Brad Setser

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Memo to John Taylor: In what sense was the Argentine crisis contained?

by Brad Setser
January 25, 2005

David Sanger goes back to his roots as the New York Times’ Treasury correspondent, and outlines the tensions that the dollar’s slide over the past few years has created. Sanger digs up a bunch of old quotes — along with a few new ones — to demonstrate the global blame game continues. The euro is too strong — and euroland growth too weak — because the Bush Administration has a policy of benign neglect toward the dollar. China’s reserves are growing faster than China wants because, well, because currency speculators are bad people — not because China’s exchange rate is undervalued and the renminbi is currently a one way bet. The US trade deficit is too big because the rest of the world won’t grow (let’s ignore for a moment that world growth was actually quite strong in 2004), not because US national savings is exceptionally low.

But the quote that really struck me was from Treasury Under Secretary John Taylor. Taylor took credit for “containing” the crisis in Argentina, along with crises in Brazil and Turkey.

There has not been an economic crisis of significant magnitude since Mr. Bush came to office. John B. Taylor, the Treasury under secretary for international affairs, said that was partly a result of preventive maintenance. “My first days on the job we had a crisis in Turkey and one coming in Argentina and Brazil,” he said. “Both were contained.”

Taylor has every right to claim credit for success in Brazil and Turkey. It has been surprising that the Administration has not trumped these successes more: presumably they are still a bit embarrassed that they contained both crises by throwing big sums of money at fiscally responsible social democrats (Dervis, Lula). That is not exactly the response to emerging market crises the Bush Administration economic team came to office promising.

Turkey in particular was no slam dunk. The Administration took a risk, and it paid off — though saving Turkey required going from providing very large, short-term bailouts to not so indebted countries through the IMF to providing very large, long-term bailouts to quite indebted countries through the IMF. Turkey still owes the IMF a large sum of money.

But Argentina? In what sense did the Administration’s policies contain Argentina’s crisis? Argentina’s economy tanked throughout 2001 as the Argentines — backed by the Fund and the US Treasury — vainly defended their own cross of gold (the currency board). And then Argentina’s economy tanked some more in 2002, when Argentina made the painful (but in my view necessary) step of getting off the currency board. And Argentina still has not cured its end 2001/ early 2002 default.

You win some and you lose some in the crisis business. No one bats 1000. But it is a bit much to claim Argentina as a success. It hardly enhances the Treasury’s credibility.Taylor often argues that the Administration’s response to Argentina in 2001 — which largely consisted of giving Argentina money to defend the currency board and avoid default — prevented Argentina’s crisis from giving rise to contagion. In that sense, the crisis was contained. The pain was confined to Argentina.

His argument does not really hold water. The bond market has plenty of time to get ready for Argentina’s default, and there was no bond market contagion. But lots of banks were surprised by the scale of their losses in Argentina, and got real cautious in other countries. Bank exposure to Brazil fell like a rock in 2002. That, to me, is a form of contagion. And then there is Argentina’s dirty little secret, or perhaps the market’s dirty little secret. There is a simple reason the “market” reacted so calmly to Argentina’s default: the institutional investors that make up the majority of the US market did not hold that many Argentine bonds by the time Argentina defaulted. Argentina had about $100 billion bonds at the time, an enormous sum. But $50 billion of those bonds (roughly) were in domestic Argentine hands, $25 billion were held by European retail investors and Japanese buy and hold investors, and only $25 billion were held by institutional players (and some of those investors had hedged their credit risk with credit default swaps). That fact — combined with the fact that EVERYONE in the US market saw Argentina coming — made it pretty easy for the external bond market to absorb Argentina’s default. Alas, it was not so easy for Argentina’s domestic financial system to absorb the impact of Argentina’s default and devaluation.


  • Posted by Marcus Stanley

    Curious what you thought of the comments in the rest of the article. It seemed like it was full of breezy wave-it-aside assurances from U.S. officials about managing the U.S. balance of payments. The whole thing is being driven by our higher growth, managing further declines in the dollar will not be too hard, etc. etc. Is this just pro forma publicity stuff, or do you think they really aren’t all that worried? What did you think of their arguments? I can infer some answers from your previous posts, but still curious.

  • Posted by anne

    There is no question in my mind that there is little worry about our fiscal situation by the Administration or Congressional leadership. A funny thing happened in California recently. The freshly elected governor and legislature began to worry about balancing the budget and chose to raise taxes. Now, choosing to raise taxes on vehicle registrations in California is even more foolish than other raises might have been, but no matter. Taxes were to be raised, and the result was a recall of the governor and a Republican governor elected in a Democratic state. Then what? The tax increase was stopped, and there were some budget cuts and there was a large amount of fresh borrowing by California and there was a wildly popular Republican governor. Republicans have learned, deficits do not lose elections, but curing deficits may well.

    I am not being cynical, simply realistic. International bankers will not dictate American fiscal or monetary policy. Right now, there are plans for cuts about the edges of spending, no new taxes, and lots of borrowing. Economic growth will solve all, so we wish.

  • Posted by brad


    Sanger argues Treasury’s influence has been diminished from the days of Rubin and Baker. No disagreement from me.

    Sanger quotes Snow delivering the administration’s line on deficits and the dollar, which is more or less we are not serious about bringing the deficit in. He would have more credibility if the FY 05 deficit was gonna come in below the FY 04 deficit — something that now looks unlikely.

    I don’t think the administration is serious about cutting the deficit. I do think the Administration is serious about trying to use the “international card” to push a Republican controlled congress to go along with some spending cuts at the margins — in part b/c they don’t like the harping from congressional conservatives about the pace of spending growth. Congressional conservatives say the growth in domestic spending is the administration’s fault; the administration wants to put Congress on the spot.

    On the other hand, I think anne is right — the plans are to cut spending at the edges, not to seriously grapple with the structural gap between the government’s revenue base and its spending commitments. The administration’s number one goal is to make the tax cuts permanent, not to reduce the deficit — cutting $5 b a year from the defense department’s capital expenditure budget, and cutting a few small government programs won’t materially reduce the deficit.

    As for the current account deficit, i have not seen any sign of serious concern — and certainly no sign of sufficient concern to engage in some sort of attempt to engineer a coordinated global policy response that might lead the deficit to shrink. A serious effort would require a serious commitment to cut actual US borrowing, not a serious effort to produce (not very credible) projections showing that W will meet his tortured pledge to cut the deficit in half by FY 09, but in 1/2 from the $500 billion forecast for the FY 04 deficit, not the actual FY 04 deficit. A serious effort would require talk of what the US can do to increase its national savings, not just (stale) calls for structural reforms in Europe and Japan to sput growth.

    And if the Treasury has any thoughts about the nexus between US current account deficits and asian reserve accumulation, they have not shared them — there is no (public) concern about the impact an successful attempt to engineer a renminbi revaluation/ broader revaluation in Asia might have on asian dollar reserve accumulation, and thus on US interest rates. Perhaps b/c they have no real expectations that China is gonna move soon, and perhaps b/c they believe that any fall in Asian demand for treasuries can easily be made up elsewhere, so there would not be much impact on interest rates.

  • Posted by Marcus Stanley

    Yes, it seems like they think they can manage this whole thing without serious interest rate movements or serious inflation induced by rising import prices. Like the Plaza accords or something, makes your vacation more expensive but hey, no big deal. How many serious economists really believe this is the question for me. Back of the envelope macro 101 calculations seem to show that some serious pain will eventually come with readjustment (assuming that the adjustment does not come thru export growth, which it almost certainly won’t), but it seems like there is a big school within the administration that just does not buy those calculations at all. Do you regard a pain-free adjustment as a serious possibility? I guess that’s what this whole blog has been about for a while now, so kind of unfair to ask it as a question.

  • Posted by anne

    A couple of years before the economic crisis in Argentina, Wall Street Week was broadcast from Buenos Aires. Louis Rukeyser gushed over the effect of the currency peg with Domingo Cavallo. But, even at the time Argentina was slowing in growth for the dollar was strengthening and so was the pegged Peso. Argentina was losing demand for exports as the Peso rose in value from Spain and Brazil and Chile which were far more important trade partners than America. But, the currency peg was a terrific assurance for international investors in Argentine assets. We watched as Argentina’s economy went from slow growth to recession to depression, and the currency peg was kept with the sanction of America. The damage in Argentina should not be easily forgotten. America did not rescue Argentina.

  • Posted by brad

    anne, true, true. Nouriel and I have argued that an alternative path through the crisis (an earlier move off the peg and an earlier restructuring, backed by imf lending) might have resulted in a smaller cumulative fall in output.

    Marcus. adjustment w/o pain. no. there will be some pain. consuming more than you earn is always more fun than earning more than you consume. The bigger question is whether, with appropriate policies, “rebalancing” that reduced the current account deficit might be possible without any huge fall in growth. That scenario involves some reduction in the pace of import growth, some fiscal retrenchment (both to reduce demand and to reduce the uS borrowing need), a gradually weakening dollar that spurs export growth, and strong world demand growth. That might give you a 0.5% fall in the trade deficit over a ten year period, or maybe a slighly faster fall along with GDP growth. (nouriel roubini and i spelled out this scenario a bit in our external adjustment paper).

    but for that to happen, the shift from a rising to a falling trade balance needs to happen soon, or the shift is unlikely to be gradual. And it only works if US demand growth lags US income growth, and world demand growth exceeds world income growth. Neither happened in 04. Soaring US imports offset the impact of a weaker dollar and strong global growth on US exports, and while global demand growth was strong (see commodities), it still lagged world income growth. China invested a ton, but saved even more …

  • Posted by anne

    Paul Krugman suggested gently several times that the peg be dropped as the damage was apparent. Joseph Stiglitz has written well on the IMF’s perverse urging of Argentina to keep the peg.

  • Posted by anne

    Development is such a tough field. Till the Chinese breakthrough a century of sad development ends was witnessed. If ever a field was little understood. The Chinese may may may be changing what we know of development and providing a model from India to Brazil to South Africa. So, if the leadership is hesitant to change the model we can understand even as we worry.

  • Posted by anne

    Let the Competition Begin

    BEIJING – China is better known for making most of the world’s sports shoes rather than wearing them, but the world’s biggest athletic shoe brands are in a race here to change that.

    Adidas-Salomon announced Monday that it would be a major sponsor of the Olympic Games in Beijing in 2008. Chinese athletes will wear the Adidas brand shoes and sportswear throughout the Games.

    The announcement was part of Adidas’s ambitious hopes for China. The company, based in Germany, intends to increase its stores in China to 4,000 by 2008 from 1,300 now, and to expand its China revenues to more than 1 billion euros ($1.3 billion) by the end of the decade.

  • Posted by anne

    Venezuela Tensions Worry Oil Executives

    HOUSTON – Venezuela may be increasing tension in energy markets with decisions that are confounding international oil companies, but the government there says it is merely seeking more income and new markets for its oil.

  • Posted by anne

    What should be especially worrying is the combination of federal deficits and low household saving levels means that we must import ever more capital to fund our consumption. Thus, claims against earnings from American assets are piling up abroad. Earnings that we will need in future will be claimed by international investors.

  • Posted by Taj

    To think about cutting the budget deficit – how much flexibility does US have in actually reducing it. Walking out Iraq or Afghanistan is not an option – this means both human and capital costs will continue to rise. Most other programs are being slowly trimmed any way. Raising taxes could mean slower growth or even recession. Also the drop in consumer demand due to higher taxes et al could mean bad news for the Chinese bicycle economy, which in turn may be forced to pull the financing plug on US govt leading everyone into a downward spiral.