No Value in Devaluation
Argentina looks to be at the point of no return.

Mr. Malpass is the Chief International Economist for Bear Stearns.
December 4, 2001, 8:00 a.m.

The market's October-November view was that the impact on Brazil would be limited by the size of Argentina's economy (small) relative to Brazil's. But it seems more certain that there will be substantial contagion to Brazil and later to other developing countries.

The contagion will occur through a paralysis of investment in South America — through Brazil's huge debt burden and through the legal processes being established to carry out Argentina's default. A devaluation/default will raise the cost of capital in other developing countries, slowing their growth and making their debt burdens heavier. This contagion through weakness in real economies (in contrast to the Asian contagion through exchange rates) is particularly difficult to counteract during a period of weak global growth.

Devaluation Watch
In Argentina, overnight interest rates and the peso forward exchange rate imply a high-market risk of imminent devaluation. Both rose sharply on November 29, dragging debt and equity prices down. In Brazil, debt and equity prices all fell sharply. The Bush Administration's message to Argentina around the November 11 presidential meeting was strictly IMF-speak: balance the budget and restructure the debt. The omission of a call for sounder money for Argentines implies a willingness to see Argentina devalue.

There is speculation that the IMF staff currently in Argentina is considering a devaluation for competitiveness purposes (note the IMF's key role in collapses in Thailand and Indonesia in 1997 and Turkey in February). But devaluations have historically worked poorly in creating the investment flows and structural changes needed to cause competitiveness.

There has also been no discernable movement in Argentina toward dollarization; there has been no announced contingency plan and no government explanations of the technical feasibility of dollarization. This tilts the odds increasingly toward devaluation as the banking system deteriorates.

On November 26, Argentina's central bank began setting a reference-rate ceiling for commercial bank interest rates. This step will only accelerate the problems in the banking system and push Argentina a step closer to devaluation. On the same day, in a speech to the National Press Club, new IMF Deputy Director Anne Krueger reportedly envisioned capital controls to counteract capital flight in the event of a
sovereign bankruptcy. She was not directly addressing Argentina, but an IMF slant toward drastic non-market measures implies a tolerance for an Argentine devaluation.

In that speech, Krueger also reportedly laid out a process to explore an IMF-led global bankruptcy system, apparently with U.S. government participation.

As Argentina flounders, it would have been a helpful signal for the IMF to discuss, for example, "techniques to perfect currency board systems" or "solvency and growth through sound money and low tax rates." To focus instead on drawn-out discussions over the international legal system seems to be an invitation for a worst-case outcome for Argentina and prolonged downward pressure on Brazil.