A Cross of Dollars

SYNOPSIS: It goes without saying that a country needs to be able to use monetary policy to fight recessions, but that's not what's happening in Argentina

When Franklin Roosevelt took the United States off the gold standard in 1933, his budget director was aghast. "This is the end of Western civilization!" he declared. In fact, the real threat to civilization was the Depression and its political consequences, and one shudders to think what might have happened if Roosevelt hadn't defied monetary orthodoxy.

Unfortunately, that old-time economic religion, with its narrow-minded insistence on monetary rectitude at the expense of every other consideration, has had a revival in recent years, thanks largely to the promotional efforts of right-wing think tanks. And that ideology, more than anything else, is responsible for Argentina's looming catastrophe.

As little as three years ago Argentina's "currency board" monetary system was the subject of extravagant praise in publications like Forbes and The Wall Street Journal, and economists at the Cato Institute established lucrative consulting practices advising other countries to mimic Argentina's approach.

Why this enthusiasm on the right? Basically, the currency board introduced in 1991 to reassure investors returned the country to the gold standard, except that greenbacks took the place of ingots. To prevent future inflation, the system rigidly pegged the value of the peso at one dollar, and left very little discretion in monetary policy.

So what went wrong? You might think, given all the talk of debt default, that the problem was government profligacy. But Argentina's budget deficit has ranged between 1 and 3 percent of G.D.P., not bad for a depressed economy, and its government debt is only about half of G.D.P., better than many European countries. By the numbers, Argentina's fiscal picture looks better than America's did a decade ago.

The real problem with Argentina isn't fiscal, it's economic. The country is now in its fourth year of grinding recession. But the rigidity of its monetary system, designed to protect against inflation, precludes any of the actions that countries normally take to fight deflation, such as cutting interest rates or letting the currency depreciate. Instead, Argentina has gone through wave after wave of fiscal austerity, each time with the promise that the latest round of wage and job cuts would restore confidence and produce economic recovery. But austerity has not brought recovery. On the contrary, it has worsened the recession, increased social tension and further reduced confidence.

The natural answer is to remove the straitjacket: let the peso float, and do what is necessary to save the economy. That's what Britain did in 1931 and again in 1992, both times to its advantage; even Brazil, forced off its currency peg in 1999, found that floating its currency greatly improved its economic position.

Admittedly, the fact that much private debt in Argentina is indexed to the dollar means that a peso devaluation might create financial problems. But as Ricardo Haussman, former chief economist of the Inter-American Development Bank (and a strong advocate of sound money), has pointed out, there is an answer: Simply issue a decree canceling the indexation. It's a radical solution, but the situation is desperate, and there is precedent: it's more or less what Roosevelt did in 1933. And some investment bankers have privately supported such a plan for months.

But since last spring conservative economists in the U.S. have been urging Argentina to preserve its dollar peg and default on its debt instead. And that's what's happening.

I've written before about an apparent double standard for economic policy in the third world, but this is truly bizarre. Advanced countries often devalue their currencies but Argentina is being told that it can't. On the other hand, advanced countries never default on their debt but Argentina is being told that it must. And this even though Argentina isn't heavily in debt by normal standards, and default which won't let Argentina cut interest rates, won't make its goods more competitive and won't end the need for draconian fiscal austerity will do nothing to end the economic crisis.

It's hard to believe that Argentina will sacrifice not just its economy but its credit rating on the altar of a discredited monetary theology. But as you read this, Argentine officials are crucifying their long-suffering nation on a cross of dollars.

Originally published in The New York Times, 11.7.01