from Follow the Money

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

January 25, 2005

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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.

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