Amid news of political campaigns, volatile stock markets and the Middle East, it has been easy to miss the worsening economic and political problems in Uruguay, Brazil and Paraguay. But the situation is dire, and questions have arisen over the wisdom of bailing out the three countries.
The three nations faced incipient banking and foreign exchange crises, mimicking the process that began in Argentina nine months ago. The banking component was most severe in Uruguay, where the public began to withdraw deposits in rapidly increasing numbers in late July.
Virtually all banks in Uruguay were unable to meet demands for cash. The first week of August, the national government imposed a bank holiday and asked for emergency assistance from the IMF, a multilateral agency based in Washington.
The IMF produced a loan package and the Bush administration loaned Uruguay $1.5 billion to tide it over, allowing banks to reopen until the IMF funds actually arrived. The situation has stabilized somewhat, but the small country faces recession and continued economic turbulence.
Brazil did not have similar bank runs, but the Brazilian real, which had been losing value at an increasing rate for months, seemed to be spinning out of control. The central bank possessed limited resources to meet demand for dollars. Heightened fears of exchange rate risk were drying up foreign investment and even short-term trade financing.
Brazil is in the middle of a presidential election campaign. Investors fear that the leading candidates will pursue populistic but imprudent policies that will worsen economic performance and make it difficult for foreign investors to recover their capital.
The IMF announced a $30 billion loan package, $6 billion of which was disbursed immediately; $24 billion was held in abeyance for use in 2003 if the country continues to meet economic performance targets.
The IMF also relaxed past agreements so Brazil could use up foreign exchange previously held in reserve. This was one of the largest loan packages ever put together by the fund, but the real continues to slip.
Paraguay, a much smaller and more primitive economy, was threatened with both bank and foreign exchange runs on a lesser scale.
Is IMF lending to these nations appropriate or not? Many argue that it allows them to stabilize their economies and return to growth, while also benefiting the U.S. and global economies. South American countries are important U.S. trade partners, and they buy far more U.S. and Minnesota exports when their economies thrive than when they are in a crisis.
Moreover, equity markets and the global financial system are fragile right now. Full-fledged crises that would cause Uruguay and Brazil to default on their debts would be a blow to international banks that are already under pressure. In such an atmosphere, many prefer to be safe rather than sorry.
Finally, these countries are generally friendly to the United States, and we might lose valuable diplomatic support in the region if we stood aside while they spiraled into economic crisis or if we vetoed action by multilateral institutions such as the IMF.
But there are also arguments against action, some of which have been voiced by Treasury Secretary Paul O’Neill in the past. The international financial situation may be exacerbating the region’s financial problems, the argument goes, but the root causes lie in decades of bad economic policies and these nations’ chronic inability to balance their budgets.
Unproductive government spending leads to budget deficits that soak up all private savings and more. Inflation is chronic and this constellation of confiscatory bad policies teaches people to save their money in Miami or not at all. This intensifies the need for foreign capital and accentuates vulnerability to international flows that are highly sensitive to rumor, fear and speculation.
IMF actions may play a negative role in this. The likelihood of IMF bailouts encourages international banks to lend money when it is imprudent just as insurance gave an incentive to the Keatings and Greenwoods who owned savings and loans to pour depositor money into questionable investments in the 1980s.
What is in effect subsidized capital allows Latin societies to continue to avoid facing fundamental problems. Like giving a bottle of whiskey to an alcoholic, continued capital flows just delays eventual long-term recovery.
Which view is correct? For years I was convinced by arguments that IMF assistance could lead to gradual reform. However, over the past decade it seems increasingly clear to me that Latin America would be better off in the long run if the IMF were abolished, and if Latin populists had to stew in their own juices.
But the adjustments inherent in such a tough love approach would not be pretty, as ongoing events in Argentina show. And if I were in the administration right now, I would probably recommend the better-safe-than-sorry approach.
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.