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ARGENTINA'S ECONOMIC MELTDOWN: CAUSES AND REMEDIES
WEDNESDAY, FEBRUARY 6, 2002,
U.S. House of Representatives,
Subcommittee on International Monetary Policy and Trade,
Committee on Financial Services,
The subcommittee met, pursuant to call, at 10:05 a.m., in room 2220, Rayburn House Office Building, Hon. Doug Bereuter, [chairman of the subcommittee], presiding.
Present: Chairman Bereuter: Representatives Toomey, Capito, Ferguson, Frank, C. Maloney of New York, Carson, Sherman and Sanders.
Chairman BEREUTER. The hearing will come to order. I apologize for the cramped conditions of the room, but our major hearing room is under renovation at the moment. We'll follow the normal Committee rules with respect to the Ranking Member and this Member and limiting us to 5-minute opening statement and other Members who might appear 3 minutes. We have many conflicts, including some mandatory conferences going on right now.
In any case, the Subcommittee on International Monetary Policy and Trade meets today in open session to examine the financial crisis in Argentina, including the activities of the International Monetary Fund (IMF) within this country. The subcommittee will hear from the Under Secretary of the Department of the Treasury for International Affairs, Dr. John Taylor, on the subject of Argentina, as the Department of the Treasury is responsible for implementing U.S. policy toward the IMF.
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The subcommittee has jurisdiction, of course, over international monetary policy generally and the United States' participation in the IMF, both of which are relevant to today's hearing. This is the first hearing under my Chairmanship of this subcommittee which addresses the activities of the IMF as it relates to a particular country. Last year, the subcommittee focused on the regional multilateral development institutions and the Export-Import Bank.
At the outset, I would like to convey to the subcommittee Members the sensitive nature of the political and economic situation in Argentina. For this reason, I would urge the Members to not focus on the internal workings of the Argentine government, but to instead focus on the Argentine policies which are relevant to any future IMF or U.S. assistance to the country.
Before introducing our distinguished witness, I would like to remark upon the overall fiscal situation in Argentina. At each subcommittee Member's desk, the following two products are found. The Congressional Research Service has provided, at my request, a chronology of events in Argentina and a recent CRS report on the Argentine financial crisis.
The focus of today's hearing is as follows:
1. Recent Argentine political and economic history.
2. The recent economic plan supported by the Argentine government on February 3, 2002.
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3. The recent role of the IMF in Argentina.
4. The recommendations of the Meltzer Commission and its dissenting views as it relates to the IMF preconditionality criteria for Argentina; and fiveand I'll do this by unanimous consent
5. Extending my remarks, some of my own views about the IMF. Because of the limited time, I ask unanimous consent that I may extend my entire statement into the record.
Without objection, that will be the order.
First, in order to understand the current economic and political turmoil in Argentina, it's necessary to review recent Argentine history. In 1991, the Argentine government established a currency board to set the peso's value on a one-to-one peg with the U.S. dollar in order to curb hyperinflation. However, because the value of the dollar appreciated over the past 10 years, it became increasingly difficult for Argentina to export its products. As a result, in 1998, Argentina began to fall into a deep recession. At least that was part of the reason. By the end of 2001, Argentina had a total debt of approximately $132 billion.
Furthermore, on November 30, 2001, President de la Rua of Argentina imposed a $1,000 per month limitation on personal bank withdrawals. As a result of this restriction and other austerity changes in the Argentine government, violent protests broke out and President de la Rua was forced out of office on December 20 of last year. Over the next ten days, there were four different presidents of Argentina, including Mr. Eduardo Duhalde, who is currently in power.
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When Mr. Duhalde took over as President, he implemented immediate economic reforms. He announced the end of the currency board with its peg to the dollar and his plan for the devaluation of the peso. President Duhalde implemented a dual exchange rate in which the peso was floated for financial transactions and fixed the ratio at a 1.4 pesos to the dollar for foreign trade and certain other transactions. He also continued the freeze of bank deposits in dollars over certain thresholds.
Second, on Sunday, February 3rd, 2002, the Argentine government came forth with a new economic plan, which would completely free float the local peso currency and loosen an unpopular freeze on bank accounts. This new economic plan was in part a response to the decision of the Argentine Supreme Court which declared the current freeze on bank deposits to be unconstitutional. To further illustrate the current political and economic instability in Argentina, their Congress is considering impeaching the judges who rendered the decision.
Furthermore, the Argentine government on February 3 announced it would turn all dollar debts into pesos at a rate of one-to-one. This change would help debtors pay back their loans since it will reduce the value of their debt substantially because the floating value of the local peso is at a volatile actual market rate of around two pesos per dollar. However, both the creditors and the banks will suffer losses because of the pesofication of debt. Furthermore, this economic plan also turns all dollar deposits into local pesos at a rate of 1.4 to the dollar. This devaluation of deposits has angered middle class demonstrators, of course, because of their loss in savings.
Argentina declared a bank and foreign exchange rate holiday on Monday and Tuesday of this week to prepare for the new economic measures. The effectiveness and political ramifications of these reforms remain an open question.
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I ask unanimous consent, in order just to cover the background, that both the Ranking Member and I have 2 additional minutes of the normal Committee rules. Without objection. Thank you.
Moving on, third, it's important to note that Argentina has received extensive assistance from the IMF over the past years. For example, in March 2000, the IMF agreed to a 3-year, $7.2 billion arrangement with Argentina. Moreover, in January 2001, the IMF augmented its earlier agreement by pledging another $7 billion for it as part of a larger $40 billion assistance package which involves the Inter-American Development Bank, the World Bank, Spain, and private lenders. However, due to the fiscal instability in Argentina, the IMF withheld its $1.24 billion loan installment on December 5 of last year.
Fourth, the concept of preconditionality for IMF assistance was endorsed by the majority report of the Meltzer Commissiona controversial recommendation. I take particular interest in the Meltzer Commission, because I'm the father of that legislative language which ended up in an Omnibus Appropriations Act in 1979.
This Commission, which completed its work in March of 2000, was charged with studying the future of the IMF, the World Bank, and the regional multilateral development banks. I would encourage Members and their staff to review both the majority report and the dissenting views of the Meltzer Commission, as I find them very instructive regarding this controversial recommendation.
With respect to the preconditionality for IMF assistance, it appears from press reports that both the IMF and Secretary of the Treasury Paul O'Neill support some form of IMF preconditionality as it relates to Argentina. Examples of preconditionality include the free-floating of the local Argentine peso and the reduction of deficit spending. I do see, of course, merits of a country having a sound economic structure in place before receiving IMF assistance.
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With that background information in mind, I'd like to introduce Dr. John Taylor, the Under Secretary of the Treasury for International Affairs, who will, I am sure, assist the subcommittee in examining these important issues. Dr. Taylor has a very distinguished academic and professional record. He received his undergraduate degree from Princeton University and his Ph.D. from Stanford University. He's taught economics at Columbia, Yale, Princeton and Stanford University. He has also directed the Monetary Policy Research Program at the Stanford Institute for Economic Policy Research. In addition to these academic positions, Dr. Taylor was a member of the President's Council of Economic Advisers during the Administration of President George Herbert Walker Bush. Moreover, he has also served in the private sector as an analyst for Alan Greenspan's Wall Street firm, Townsend-Greenspan, in the late 1970s and early 1980s.
Dr. Taylor, we welcome you to these hearings, your first appearance before a subcommittee. And before we move to you, I'd like to turn to the Ranking Member of the Minority, the gentleman from Vermont, Mr. Sanders, for 7 minutes if he'd care to use them.
Mr. SANDERS. Thank you, Mr. Chairman, and welcome, Dr. Taylor. I think we all know that Argentina today is in a major financial crisis. Unemployment is about 17 percent. The economy is in its fourth year of recession, and the country is now in the process of defaulting on its foreign debt.
I am sure that there is a lot of blame to be spread around regarding the Argentine financial crisis. Generally speaking, it is not our job to try to get involved in the internal financial crises of countries all over the world. My interest, and what I think is relevant to this subcommittee is that we are the international financial organizations subcommittee, which deals among other things with the IMF. So what interests me is what role the IMF may or may not have played in precipitating or expanding the crisis that exists in Argentina. And obviously there are a lot of differences of opinion about that.
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Let me just quote, if I might, from an article that appeared in the American Prospect by Robert Kuttner, an economist from Massachusetts. And he says, and I quote: ''Argentina followed the IMF model faithfully, more faithfully, than almost any other nation. Its economy was opened wide. Its peso was pegged to the dollar. For a few years this sparked an investment boom as foreigners bought most of the country's patrimonyits banks, phone companies, gas, water, electricity, railroads, airlines, airports, postal service, even its subways. As long as this money came in, there were enough dollars to keep plenty of pesos in circulation. But the dollar-to-peso peg led to an overvalued currency which killed Argentine exports, and once there was little more to sell off, the dollars ceased coming in, which pulled money out of local circulation. As Argentina tanked, the IMF's austerity program pushed the economy further into collapse.''
There was another op ed that appeared in the San Francisco Examiner about 2 years ago, which indicated that about 2 years ago, Argentina signed a technical memorandum of understanding with the IMF which required Argentina to cut its budget, slice civil services salaries by 15 percent, and cut pensions by 13 percent. If Argentina followed this program, the IMF argued, their production would increase by 3.7 percent. Instead, production fell by 2.1 percent. It has now dropped off the charts.
In other wordsand I won't go into great detailwhile in general it is not our business to worry about the internal affairs of Argentina, Brazil, Colombia or any other country, what should interest us is that the role the IMF has played not only obviously in Argentina, but in countries around the world. And some of us for many years have had a great deal of concern about that.
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So I, Mr. Chairman, would yield back the balance of my time. And Dr. Taylor, I would appreciate in your remarks if you might want to say a few words about the role of the IMF.
Chairman BEREUTER. Thank you very much, Mr. Sanders. I ask unanimous consent that the other Members now in attendance have 5 minutes instead of the usual 3 under Committee rules if they care to use it. And then for people coming in after this point, we'll revert to the normal 3 minutes if they wish to be heard.
The gentleman from Pennsylvania, Mr. Toomey.
Mr. TOOMEY. Thank you, Mr. Chairman. In the interest of hearing from Mr. Taylor sooner rather than later, I will yield back the balance of my time and wait to have a chance to ask some questions.
Chairman BEREUTER. Thank you, Mr. Toomey.
Mr. Frank, the gentleman from Massachusetts.
Mr. FRANK. Mr. Chairman, this is a very important hearing and I appreciate your having it and I appreciate Dr. Taylor being here. Obviously we've got a short-term crisis in terms of the violence that was aimed at us, and dealing with that violence is going to take a lot of our energies. But there is an ongoing fundamental public policy issue that we have to address of which this hearing is a part. And it is the question of how do you promote policies in the world that increase prosperity without so exacerbating inequality that social tensions reach the point where it interferes with progress?
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We've got a worldwide consensus that capitalism is without question the best way to generate wealth. There was a few years ago a consensus that said in addition to a capitalist system, you needed to make that work by a very minimalist public sector approach. And that I think has been called into question by events. When Franklin Roosevelt became President, he made the decision to try to preserve the capitalist system. There were some hems and haws in how he ultimately decided to do that. But the notion was that we would have the capitalist system plus a Government role involving some regulation and some intervention to provide social equity.
Our challenge today is to try and duplicate that kind of approach on the global scale. Now it's extremely harder. You're not dealing with one sovereignty. But it's the same kind of intellectual problem. How do you give full rein to the capitalist system, which after all depends on inequality to work, if you do not have people unequally rewarded according to how hard they work, how smart they invest, how cunningly they anticipate public needs, and so forth? Then you don't get the wealth creation. What I believe and many others, and I think this was what Franklin Roosevelt argued, there is a point beyond which the inequality can become dysfunctional. That it can be more than is necessary to give the proper incentives. There is also a need for some forms of regulation.
A few years ago it seemed to me we were close to a consensus among policymakers that essentially all you needed to do was to remove the restrictions on capital and let capital find its most profitable niche anywhere in the world, and we would be, on the whole, better off. I think that that has been disproven by a good number of events. Clearly, the thrust of the New Deal was to say, yes, we want capital to be able to find its best area of return, but not without other factors being taken into account. Again, it's much harder to do that internationally.
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Argentina for a while was an example of the success of a fairly unrestrained capitalism. And what we have seen now is that in the global economy, that is not enough. And this is the point we have to makeno matter what people think about the appropriate public policy, there is a reaction now within Argentina politically to people have perceived to be that fairly unrestrained capitalist model that may be going further than is reasonable. Certainly, it's going further than is reasonable in many people's minds. And you see these connections. This Administration has made a free trade agreement for the Americas a high priority. That's endangered in part by the political reaction you are seeing in Argentina.
So this, to me, is part of an ongoing effort to try to find a way to harmonize support for the capitalist system with attention to the kind of policy issues that Franklin Roosevelt successfully launched here in the United States. And unless we can come up with a better balance, I think we will continue to have these problems. I would just point out I was encouraged to see in the world economic forum in New York City, at least as it was reported to meI wasn't therethe discussion was somewhat different and I would say more balanced than it had been before. There was more concern about the social aspect. And this is our challenge: How do you maintain globally a system in which capital is free to do its job of creating wealth, but not in a way that so exacerbates tensions and inequality either within countries or between countries where, ultimately, popular resistance will bring it down?
Chairman BEREUTER. Thank you, Mr. Frank.
The gentlelady from West Virginia, Ms. Capito.
Page 11 PREV PAGE TOP OF DOC Segment 1 Of 2 Ms. CAPITO. Thank you. I don't have an opening statement.
Chairman BEREUTER. Thank you very much. For the information of the subcommittee and others interested, we will be holding the next round of hearings on the subject on March 5th. We will have private witnesses and perhaps other Administration testimony as well.
Dr. Taylor, Mr. Secretary, we welcome you, as I said, to the subcommittee for your first appearance here. Your entire statement will be made a part of the record. I am not imposing any time limits on your comments, your presentation, because I want you to deal with it as thoroughly as you feel comfortable. Thank you. You may proceed as you wish.
STATEMENT OF HON. JOHN TAYLOR, UNDER SECRETARY FOR INTERNATIONAL AFFAIRS, U.S. DEPARTMENT OF THE TREASURY
Mr. TAYLOR. Thank you very much, Mr. Chairman, Mr. Sanders and other Members of the Committee for inviting me to this hearing on a very important topicthe economic situation in Argentina.
Let me first say that what's quite clear is that the people of Argentina are facing extremely difficult and trying times. And as President Bush has made very clear, Argentina is a close friend and a close ally, a country that we're interested in supporting. We want Argentina to succeed economically, become an engine of economic growth for its people and for the whole hemisphere.
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In my written testimony, Mr. Chairman, which I would like to put in the record, I reviewed recent events in Argentina, a description of the IMF program and what U.S. policy has been not only regarding Argentina, Latin America, but emerging markets in general.
In my oral remarks here I'd like to focus on the events in Argentina itself. I think it's very useful to go back, as you did, Mr. Chairman, in your opening remarks, to the early 1990s when the government of Argentina took on a series of very important economic reforms. Perhaps most visible and effective is the one you referred to. That is, the conversion of monetary policy to what was formerly a highly inflationary policy leading to inflation of over 3,000 percent per year, so-called hyperinflation, changing that policy to a convertibility law, which not only pegged the peso one-to-one with the dollar, but limited the amount of money creation that the Central Bank could generate. That in itself was a major shift in policy.
There was also a move to fiscal policy which led to better control, if you like, to more fiscal discipline in the privatization program that Mr. Sanders referred to in his remarks. I also think it's important to note that there was removal of barriers to trade and international investment.
If you look at the effects of these reforms, I think there's no question that they were quite impressive and remarkable. Of course, the hyperinflation ended, to many people's amazement, very quickly, from over 3,000 percent to nearly zero in short order.
There was also an increase in economic growth from negligible amounts in the 1980s, near zero, slightly negative, to growth over 4 percent in the early 1990s and into the mid-1990s. Investment in exports grew remarkably rapidly during this period. That is, through the 1990s.
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I think when you evaluate the impact of economic reforms, it's very important to pay attention to the response of these market-oriented reforms, as I've just indicated.
As I look at the situation, the policies began to change in the mid- to late 1990s. And also there were a series of external shocks that affected the economy. The thing that I focus on is that the government budget deficits began to increase quite noticeably, an indication of a waning of fiscal discipline if you like. That caused the debt to begin to rise more rapidly. It began to raise concerns about sustainability of the debt. Risk premium began to rise, and of course higher risk premium means higher interest rates, which in turn, tends to reduce economic growth.
This increase in debt itself was compounded by several other problems. One, a persistent deflation which continued into the late 1990s into 2000 and 2001; a depreciation of currencies that Argentina trades with, in particular countries in Europe and Brazil, which led to less competitiveness in the Argentine economy.
I think it's also important to note that expectations, persistent expectations of depreciation of the peso, even in the face of the convertibility law where the Currency Board created interest rates in Argentina higher than they would otherwise be. In particular, peso interest rates higher than dollar interest rates. That, in turn, tended to reduce economic growth, as anyone can see in any other country.
These difficulties of low growth, of growing debt, high interest rates, continued right through last year and culminated at the end of last year in the events which really brings us here today.
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It became increasingly clear to the government of Argentina and to private participants in the markets, that efforts to adjust the budget were just not working. Economic growth was not increasing. And therefore, it became clear that the debt profile was becoming unsustainable to a greater degree over time. And that's why last fall the president of Argentina at that time, President de la Rua, decided that he would restructure the government debt to bring the debt burden down to more manageable levels. Very significant announcement at the time.
However, as that restructuring was underway, because there had been so few restructurings of sovereign debt over time, there's always a great deal of unpredictability over how it will proceed and delays. In any case, as that restructuring was proceeding, uncertainty about its impacts began to develop, in particular uncertain about its impacts on the banks which had held some of that debt. This uncertainty began to lead to large deposit withdrawals. People in Argentina would be withdrawing their deposits from the banks. And in order to stop these withdrawals, the de la Rua government decided to impose restrictions on those withdrawals from the banks.
Soon after these restrictions were imposed, we began to see the social and political protests which unfortunately turned violent, and President de la Rua then resigned.
If you think of where we are right now, it's clear the economic circumstances in Argentina have deteriorated since the imposition of these restrictions on deposit withdrawals. Right now there's a lack of a functioning payment system, which brings economic activity to a near halt. There's a shortage of liquidity because people are restricted in how much they can bring out of the banking system.
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What we see now, however, is Argentina is beginning to find ways to remove these restrictions and to restore liquidity. It announced last Sunday the outlines of an economic plan to gradually remove the restrictions, to float the peso, which will allow the Central Bank to provide more liquidity. They've announced that the amount of liquidity provided will be limited to a certain amount, thereby constraining the inflationary forces that could otherwise be created by the provision of liquidity, and I think through these measures will effectively be freeing up the payment system so that economic activity can begin again.
The government of Argentina has just given the outlines of a broader plan with changes in the revenue sharing agreements with the provinces, changes in the tax system. And those changes also must be made if Argentina is to grow again. Economic growth is the most essential thing for the Argentine economy, for the people of Argentina. And I think we're encouraged that the steps have been taken. In fact, Secretary O'Neill just said earlier this week that he's very encouraged, and I certainly endorse this, that Argentina is beginning to take substantive steps to address these economic problems.
So I'd like to leave it at that, Mr. Chairman, in my opening remarks and take questions as you and the other Members see fit. Thank you very much.
Chairman BEREUTER. I thank you very much, Secretary Taylor. We will now proceed under the 5-minute rule and perhaps we'll have an opportunity for a second round of questions too if we don't have many more Members attending.
We have such incredible levels of social and economic agitation today in Argentina that one has to wonder if the prescriptions that might be recommended by the IMF, whether or not they're the correct prescriptions, can be swallowed. And it certainly is a very difficult situation for the President and for the Congress and the other governmental institutions.
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I'd like you to comment on three items if you could. One, to what extent do you think that the external factor of the Brazilian devaluation was a major factor in the problems that Argentina faces, especially in light of their membership in MERCOSUR with Uruguay?
Second, what do you have to say about the dollar-to-peso peg and the length of time in which it was put in place, given the accelerated value of the dollar? Hong Kong, of course, has a direct peg, too. And although people have tried to break it, they've not been successful. But then Hong Kong has fiscal discipline and more than $90 billion in reserves.
And finally, at least, I would like to start you down a path if you have time to talk about the recommendations of preconditionality for IMF assistance to a country as recommended by the Meltzer Commission, but strongly objected to by the minority opinion.
Mr. TAYLOR. Thank you very much, Mr. Chairman. With respect to your first question, the effects of the depreciation of the Brazilian currency, and for that matter, the depreciation of the euro relative to the dollar, I think these were certainly factors in preventing Argentina from growing more rapidly in the last 2 or 3 years. It is not the only factor.
Argentina is, at this point in time, not as open as one may think in the sense of the fraction of exports, the GDP is relatively low. It's not much different than the United States, in fact. It's not nearly as important for the overall economy as other small open economies in Latin America.
Page 17 PREV PAGE TOP OF DOC Segment 1 Of 2 So I think it's important to look at other factors in addition to the depreciation of the real and the euro here. And to me, those are the higher interest rates generated by basically expectations of depreciation of the peso, which generated higher interest rates in Argentina.
And I think also these changes in policy which I referred to, basically a movement back away from reforms where the deficits were beginning to increase again and raising questions about debt sustainability, I think that policy shift maybe not so noticeable at the time, certainly not as noticeable as the remarkable change that occurred in the early 1990s, but a gradual shift away from those things, the fiscal discipline, the move toward privatization, and so forth. I think that also is an important part of the growth slowdown and negative growth.
Taxes have to be favorable for economic growth. The tax system in Argentina is not as favorable as it could be. So I would add all those other reasons to the depreciation itself.
With respect to the dollar-peso peg itself, I always say when I talk about this that that provided an enormous degree of stability to the Argentine economy because it ended the hyperinflation. In fact, it was a very popular law among Argentine people, because of the end of the hyperinflation which has very painful memories in most people's minds.
There's no exchange rate system, however, which works perfectly in all dimensions. And pegs, even very strong pegs, have the disadvantage of not allowing changes in the exchange rate. And sometimes it's better if those occur. I am of the view that if you have pegs, they should be as strong as possible. For example, the European Union effectively has pegs for the countries in that union. It's very strong and effective. Greece is joining the European Monetary Union, thereby pegging its currency in a more or less permanent way with the euro. Those are very strong, very credible, and don't have the difficulties of credibility that other kinds of pegs do. So the interest rates in Greece will converge very quickly to interest rates in the rest of Europe. That did not happen in Argentina. Interest rates in Argentina, the peso interest rates, were generally higher than dollar interest rates because of the possibility of depreciation or devaluation.
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I think at this point in time, the Argentines have chosen to have a flexible exchange rate. They recognize that that means there will have to be other ways to contain inflation. And they have outlined a program whereby the Central Bank will limit its increase in money growth. And I think that's going to be very essential to keep inflation low, even without the convertibility law. What would be very pleasing I'm sure for the Argentine people and I know for economic growth if inflation ultimately can be at the very low levels that it was in the early 1990s after the end of the hyperinflation, and no different from levels in Chile, Brazil, which are coming down still, and for that matter, the United States.
The third question you raise about the preconditions. I think that is a very important issue. This Administration has emphasized prior actions or preconditions in many times, many programs already. Terminologies differ. I think the basic concept that you're referring to is that a country before it starts into a program takes actions which are in place and will not only make the likelihood of the program continuing greater, but will increase economic growth. And there was a program in Turkey that was developed during the course of last year, actually voted on early this week at the IMF. That program in many respects at Secretary O'Neill's urging, the U.S. Government's urging, contained I think more prior actions than many other programs. And that has been very accepted positive by the Turkish government, and they have made changes. For example, changes in the banking law, changes in privatization.
And I think the more we can have changes up front, the more we can limit the amount of conditions that have to be monitored as you go through time, I think the more effective the programs would be.
Page 19 PREV PAGE TOP OF DOC Segment 1 Of 2 So the general concept of prior actions I think makes a lot of sense, and we'll be trying to work with the IMF to have as much of that as possible.
Chairman BEREUTER. Of course, Argentina was in the midst of a plan, so that's a little bit different than the application of preconditionality.
Mr. TAYLOR. Yes.
Chairman BEREUTER. But I'll come back to that later. I'd like to turn to the gentleman from Vermont, the Ranking Member, for his comments and questions.
Mr. SANDERS. Thank you, Mr. Chairman.
Dr. Taylor, I think it's no secret to you that many people in the developing world and some of us in the United States have the feeling that the IMF to a large degree represents the interests of large and powerful multinational corporations and does not serve the poorest people of the world well. A lot of people hold that feeling. I share that feeling.
I want to, if I can, combine three questions to you and see if you can respond to them. And it deals in fact with the role of the IMF in Argentina. The Argentine government pegged its currency to the dollar in 1991. Approximately how much money did the government borrow from the IMF, either directly or through packages arranged with the help of the IMF from that point on? So number one, first question is, what kind of economic relationships existed between the IMF and Argentina? And I start off with the assumption, which is no great secret, that the United States is the 2000 pound gorilla within the IMF. We have veto power, and that reflects back on the policies that our Government develops. That's question one.
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Question two, it now seems to be recognized by the vast majority of economists that this decision of pegging the peso to the dollar was a fatal mistake and explains much of the recent meltdown. Should the IMF accept responsibility for this mistake since it supported the fixed exchange rate for years with tens of billions of dollars of loans? And then again, and obviously this was also before your time, and what about the role of the U.S. Treasury in urging the IMF forward on that policy?
Third, the IMF now claims, as I understand it, that it was against the fixed exchange rate regime all along. There is no written record of either the IMF or Treasury trying to persuade Argentina to abandon the peg. Can you think of any other country to which the IMF continued to loan and arrange loans for very large amounts of money to support a policy that the Fund thought was wrong and which if wrong could lead to economic disaster? In other words, they're saying now they made a mistake, but most of us when we look back on the IMF, the IMF doesn't lend money to countries who are not following their dictates. To clarify, we are not talking about a country missing its targets for the money supply or running a central government budget deficit bigger than what it committed to. In other words, the issue here is, to what degree should we hold responsible, understanding that the Argentines themselves of course deserve a great deal of the responsibility, but this Committee deals not with the internal workings of Argentina, but with the IMF and Treasury's role within the IMF.
So those are some of the questions that I would like to address to you and appreciate your response.
Mr. TAYLOR. OK. Thank you very much. The IMF programs that are currently actually in play, but they're in suspension if you like after December, really got started in March of 2000, the current program, if you like.
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Mr. SANDERS. If I may interrupt you. The original programs go back a lot earlier.
Mr. TAYLOR. Yes. Many programs, there was loans. The loans were repaid back, and basically I can go through all the loans that were made and then paid back, but would you like me to
Mr. SANDERS. Can we stay on the issue of the pegging of the dollar to the peso, which began in 1991? It's hard for me to believe that that was not supported, despite what the IMF may be saying today, by the IMF at that time. Could you comment on that?
Mr. TAYLOR. Right. There were programs at that time. The programs in the early 1990s, and there were loans made, loans paid back, loans made, loans paid back. And what I can do is get you the actual details of where all those stand exactly to the dollar amount if you'd like. But, there were certainlythere were programs that go back a long period of time with the IMF, IMF programs.
Mr. SANDERS. But, the simple questionand I would appreciate that if you could get it to me as soon as you could
Mr. TAYLOR. Yes.
Mr. SANDERS. But, the question is, if I am the IMF and I'm going to lend you money, and I say I'm not going to lend you money for fun. I want you to follow my policies. One of the policies I want you to do is to peg the dollar to the peso. Now in 2002, it doesn't look like such a good idea. And then I said, well, actually, that wasn't my idea in the first place. What's the story?
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Mr. TAYLOR. Well, I'm not sure where the changes of opinion you're hearing about are coming from. But let me just say, and try to answer your question in this way, the views about exchange rates, about pegs, about floating, about dollarization, about single currencies, amongst economists, amongst the private sector, evolve over time. And until the Asian financial crisis, there were many more pegs around the world than there are now. And I think partly as a result of that crisis, but partly as a result of other factors, there's been a move away from pegs of the kind that we've seen that are unsustainable.
But there's been a movement away in two directions. One direction is toward flexible exchange rates, as Brazil has recently undertaken, that Chile undertook before that. Mexico is following that kind of a policy. The movement away from pegged rates toward flexible rates. And those moves always require that the country adopt a monetary policy that focuses on keeping inflation low. So if you'll notice, each of those countries have some kind of an inflation-oriented price stability program associated with it.
The other move is toward, if you like, harder pegs. That's like dollarization is used in Ecuador. Greece joined in the European Monetary Union. Pegs which are viewed as more sustainable, that don't have the threat of causing expectations of depreciation.
I think that movement is correct. And I believe either direction is correct away from this middle ground which has caused so much difficulty.
I think that the IMF, from what I understand from what I understand of their staff, is in agreement with that basic philosophy. That the pegs in the middle here have led to difficulties. And one other recent example of this is Turkey. Turkey's IMF program started with a peg and it fell apart in the middle, and now they're in a flexible system, and I think many people think that that's working better. That doesn't mean that dollarization or single currencies is a bad idea. On the contrary, in many respects it's a good idea. What it means is these pegs in the middle are bad.
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So I really can't answer your questions about shifts in the IMF's view or saying that their view was different three weeks ago or four weeks ago from what it is now. I do knowI'll maybe finish my answer with thisthat what the U.S. Government feels is that an exchange rate decision by a country is one that is very important to emphasize the country's ownership of that. Exchange rate systems involve history of the country, involve politics, really the inner workings of a country more so perhaps than many other policies, but certainly a policy where ownership is important.
So what we have said in our policy about exchange rates is that's a decision for the country. And in terms of which works, I think my view here about the ends of the spectrum are the ones that tend to work and the ones in the middle
Mr. SANDERS. Can I ask one great big last question?
Chairman BEREUTER. I ask unanimous consent that the gentleman have an additional minute. Is there objection? Hearing none, the gentleman may proceed.
Mr. SANDERS. Thank you, Mr. Chairman.
In your view, what role did the IMF austerity program on Argentina have to bring about the current crisis?
Mr. TAYLOR. I think that the IMF has over this period of time tried to give recommendations to Argentina to get their economy growing again. I think there's many things an economy can do to increase growth. But to me, it's basically lower taxes, a more efficient tax system, if you like, tax reform.
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Mr. SANDERS. You're not asking the question, sir. The austerity program imposed by the IMF in causing the current crisis. Austerity program meaning cutting budgets and so forth.
Mr. TAYLOR. I would not characterize the IMF's program that they worked out with Argentina as an austerity program.
Mr. SANDERS. There are some who would respectfully disagree with you on that point.
Mr. TAYLOR. Of course. I know that, sir. But it seems to me that what the IMF wanted to do was work with Argentina to find a way to get their economy stable. In fact, it was the Argentine government this year that decided to move toward the zero deficit law, which I think in the terms that you're talking about would be classified as quite austere.
Mr. SANDERS. I should think so.
Mr. TAYLOR. And they did that because they wanted to continue with the program and not begin to restructure their debt. That was the decision that they made in the summer. That turned out not to be sustainable, and they're off of that program. Now the new government announced I believe yesterday a program where there would be a deficit for the year 2002.
Mr. SANDERS. Thank you very much.
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Chairman BEREUTER. Thank you, Mr. Sanders.
I want to call Members' attention to the CRS report before us, January 14th. On page 5, you'll see that the record of the IMF lending to Argentina traces back to 1986 and the repayment. Your staff may look at that to see if you agree with that. You may not have to send information. This is from the IMF website.
The gentleman from Pennsylvania, Mr. Toomey, is recognized.
Mr. TOOMEY. Thank you, Mr. Chairman. It seems to me what's vitally important for an economy is that there be a medium of exchange in which all players can have confidence. Borrowers, lenders, consumers, everybody can have confidence that the value will remain roughly constant and that there not be excessive inflation or deflation, and therefore a credible pegand I think that's an important distinction that you madecan serve that goal very, very well. And there are examples, many, in which it does.
And in fact it strikes me that contrary to the notion that the peg was the cause of the economic problems, it seems to me this is a very clear example of where free market, classic or liberal economics were working extremely well. From the history, as I understand it, and correct me please if I'm wrong, but having established in the early 1990s a solid currency in which investors and borrowers and others could have confidence, imposing fiscal discipline on the part of the government, lowering trade barriers and privatizing government entities, generated tremendous economic growth and prosperity and income growth and job growth and trade and so on.
Page 26 PREV PAGE TOP OF DOC Segment 1 Of 2 And in fact, it was when the government lost that discipline on the spending side and started incurring an unsustainable level of debt that the problems began to occur. Do you believe that the excessive level of government spending and therefore debt contributed more to the economic decline in Argentina than the fact that they chose to peg their currency to the dollar?
Mr. TAYLOR. Yes I do, Mr. Toomey. I think, just as you say, the changes made in the early 1990s had a great deal of success, and as long as they were continuing, things were working just fine. So I would point to the problem you just mentioned, is moving back from those reforms as a major factor.
It's not to say there weren't external shocks and changes in exchange rates or interest rates in the U.S. economy and other economies around the world. But I think you're pointing to the fundamental fact.
Mr. TOOMEY. My follow-up question is, by early 2000, do you recall approximately what was Argentina's debt as a percentage of its GDP?
Mr. TAYLOR. Approximatelyyou'll have to accept some round numbersapproximately 45 percent.
Mr. TOOMEY. And looking to grow significantly at the time?
Mr. TAYLOR. Yes.
Page 27 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. TOOMEY. As opposed to the United States where we're somewhere in the low thirties as a percentage of GDP and as a percentage of GDP, not likely to grow terribly significantly?
Mr. TAYLOR. It has been falling remarkably.
Mr. TOOMEY. The United States has been falling remarkably?
Mr. TAYLOR. Yes.
Mr. TOOMEY. Argentina's been going up. My question really is, do you believe it was really prudent for the IMF to contribute to increasing this debt load, which it did, from March of 2000 adding, as I understand it, over $7 billion in debt? January of 2001, another $6 billion. August of 2001 another $8 billion. Increasing the debt which arguably was significantly contributing to the very problem while there was not systematic reforms that would bring back the discipline yet that had gotten the economic prosperity in the first place? In other words, was the IMF now contributing to the problem?
Mr. TAYLOR. Well, that's a very good question. The most recent augmentation of the IMF program occurred last August. And that was for a particular purpose which was actually to stem or to halt, curtail a run on the banks. Basically deposits were being withdrawn last summer at a pretty rapid rate. And so those funds were put in there for that purpose.
The IMF makes loans. That's the way their funds are distributed. So their support is always in the form of loans. So since that was for that particular purpose, I think it would not qualify as something that would cause the dangers you refer to.
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The second part of that was a $3 billion loan which would be available if Argentina began to restructure its debt. So in other words, that loan was for the purpose of actually reducing overall loans. IMF loans are of course a much lower interest rate than Argentina has to pay in the market. And so that loan actually was used as a way, if they wanted to do it, to begin to restructure the debt and therefore reduce the debt.
However, I would say in general, your question raises some important issues. And that is, is it really correct when a country is in a high debt situation to provide loans? And the general thought about that is if you're convinced, if the IMF is convinced and the shareholders are convinced that those loans will, if you like, bridge to better times where you can see a decline in the level of debt compared to GDP, then we make sense. But, if it's just loaning to an increasingly high level of debt compared to GDP, then it doesn't make sense and it shouldn't be done. And I think that's where we have to insist on more. That we don't provide loans in those circumstances, because effectively those loans are bailing out the bondholders who at that point in time having received very high rates of return, shouldn't be bailed out.
Mr. TOOMEY. Thank you.
Chairman BEREUTER. Thank you very much. An important conclusion I think.
The gentleman from Massachusetts, Mr. Frank, is recognized for 5 minutes.
Mr. FRANK. Mr. Taylor, one of the problems I think we have is however they got into the fix, they're in it and here it seems to me there is this dilemma. The things that they need to do in Argentina to reduce the problem almost certainly will have unpleasant short-term effects on a large number of people in Argentina. And that's part of the dilemma. How do you get a democracy to do that? I mean, this is one of the things I think we have to deal with. It's a democracy, and we have a commitment in the U.S. which has been bipartisan. In fact, one of the encouraging things about Latin America is if you go back 30 years and compare it to today, democracy has clearly thrived, and it has clearly improved its standing.
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But how do we deal with that? I mean, this it seems to me is a major issue for policymakers. How do you get a democratic electorate to accept politically short-term pain? We have seen a succession of very obstreperous, and in some cases, as you point out, violent responses to things. Given what we would suggest Argentina do, do you see a problem in getting a democratic government to persuade its electorate to go for it?
Mr. TAYLOR. I think at this point in time the payment system needs to be freed up.
Mr. FRANK. What system? I'm sorry.
Mr. TAYLOR. The payment system in Argentina needs to be freed up. There needs to be at least a gradual removal of the freeze on deposits, and both of those things are going to be things that the Argentine people would like right now.
Mr. FRANK. Well, except you're saying gradual removal. They don't want a gradual removal. They want a quick removal. A gradual removal means a continuation for a while. It seems to me a gradual removal was not all that popular.
Mr. TAYLOR. At least it's an improvement from where it is. You mentioned in your question about frequently economic changes or reforms require pain in the short run in order to get the gain in the long run. And I think in this case there's a real opportunity to relieve the pain in the short run.
Page 30 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. FRANK. You're coming in in the middle of the movie, and they were there for the whole movie. That is, yeah, once you've got the freeze, it is better not to gradually relax the freeze than to keep it going, but should they have had a freeze in the first place?
Mr. TAYLOR. Well, I think in the first place it would have been better and everyone agrees that they never got to the position where they needed the freeze.
Mr. FRANK. I agree. The best way to go on a diet is never to get fat in the first place. I understand that.
Mr. FRANK. But I don't think you make a lot of money selling that as a diet plan, except maybe on the internet where you can sell anything. But the question is, given where they are todayI think you're just ducking the question, frankly. I don't understand the point of that. Yes, it is better to have a gradual, from a political standpoint, it's better to have a gradual relaxation of the freeze than to have it forever. But the problem is, if you thought a freeze was necessary at all, yeah, it would have been better not to have needed a freeze. But do you think they needed a freeze? And if they did, how do you sustain that in the face of political unhappiness even if you're going to gradually relax it?
Mr. TAYLOR. Well, as I said in my opening remarks, they imposed the freeze because of this withdrawal of deposits. And in a reserve banking system in the currency regime they were in at that time, they couldn't have this continual withdrawal of funds. That's the reason they put it in.
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Mr. FRANK. I understand that.
Mr. TAYLOR. You could say that, given that situation, they had to put the freeze in and
Mr. FRANK. Well, you could say, you want to say. I mean, you could say a lot of things. What do you want to say?
Mr. TAYLOR. Well, I want to answer your question.
Mr. FRANK. OK. Then answer my question. My question is, do you think given where they were they had to put on the freeze, and if they did, how do you deal with the political resistance to something like a freeze which is unpopular?
Mr. TAYLOR. Dealing with the political resistance it seems to me is you want to emphasize to people the benefits of getting to a better system. And if there is in any case some pain in the short run, you want to emphasize to people that that is short run and there are going to be such good gains for you in the future that you should pay attention to those.
The other thing is you can find ways to relieve the pain in the short run. In many societies, the United States included, we have ways to help people who lose their job, who have no income, and that's
Page 32 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. FRANK. But those require government spending don't they? In the short term to help people who have lost their jobs?
Mr. TAYLOR. Well, certainly.
Mr. FRANK. And they would add to the deficit. But that's the dilemma that if believing that part of the problem was an increase in government spending, then alleviating the pain in the short term.
Let me turn to one other quickly. By the way, when you talk about the long-range gains, I know you're not a Keynesian. But Keynes' political advice I think was superb, regardless of what you think of his economic advice. But public reaction, as you know, when they are told about the long run, they say in the long run we'll all be dead. The public understands that and their tolerance for long-range gain over short-term pain it's I think hard to deal with.
Chairman BEREUTER. I ask unanimous consent the gentleman have another minute so he can get his last question in, without objection.
Mr. FRANK. I have just one regional issue. The banking sector, obviously, is heavily engaged. And it seems to me there's another dilemma. Yes, people who lend money know they're at risk. On the other hand, if the result is nobody wants to lend any money in the future, we also have a problem. Have you looked at what the impact might be on a couple of major American banking institutions? And obviously I don't want to see moral hazard, but I don't want to see the reactions of any kind of support there's a total withdrawal. How do we deal with that dilemma?
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Mr. TAYLOR. Well, I think one of the biggest problems that have existed in these emerging markets in the last 3 or 4 years has been a decline in the flows going through them. If you look at a chart of emerging market
Mr. FRANK. Decline in what? I'm sorry. You said a decline in what? I didn't hear the words.
Mr. TAYLOR. Decline in capital going through the emerging markets, into the emerging markets, capital flows, if you like. It's declined dramatically in the last 3 or 4 years. And what we've been trying to do is trying to reverse that, because those flows are really what's going to help developing economies, emerging market economies grow more rapidly.
So one of the ways you want to do that is to have a more sensible IMF policy, a more predictable policy with respect to debt sustainability.
So that's a fundamental
Mr. FRANK. Is there a tension there between that and trying to totally eliminate moral hazard?
Mr. TAYLOR. I didn't hear the first part of your question.
Mr. FRANK. Is there a tension between that goal and totally eliminating any moral hazard?
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Mr. TAYLOR. I actually think it's a win-win situation. If we reduce moral hazard, create better certainty, more certainty in the markets, more predictability, I think there will be more flows into these markets. The difficulty in these markets is too much uncertainty.
What's happened in the last year, which I think we need to recognize, is that the markets have showed much less of contagion from one country hitting another country, than existed several years ago. And there are many reasons for that. But it's a very important development, and I think a favorable development, which will keep people in these markets and in fact bring more people into them. I'm not sure if I answered the full part of your question.
Chairman BEREUTER. The gentleman's time has expired. We will be able to come back if the gentleman sticks with us.
The gentlelady from West Virginia, Ms. Capito, is recognized for 5 minutes.
Ms. CAPITO. My original first question was much along the lines of my colleague in that can you restore confidence with all the civil unrest and turnover in the presidents, and so forth. Can you stem the tide of civil unrest? But I'm curious to know as well the leadover effect on other countries in South America, and certainly their economies are intertwined and where you see the reforms that are trying to be taking place in Argentina or the political situation there playing out in the rest of the continent.
Page 35 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. TAYLOR. Well, first, the fact that there has been less economic or financial contagion I think is important to note. And the emerging markets generally havethe spreads have gone down. It went up on 9/11, of course, but they've come down dramatically since then, surprisingly.
The political carryover, if you like, sometimes people call it political contagion, to answer your question on that, it seems to me that it needn't occur if we are very clear about what actually has happened and has happened in Argentina. One thing I've tried to do in my testimony is indicate that it's not economic reform, it's not market principles. It's not fiscal discipline. It's not low inflation that caused the problems in the Argentina, it was moving away from those principles.
So if anyone wants to draw lessons from that, that seems to me that should be the lesson. And that suggests that there shouldn't be a movement away from good economic policy that seemed to work in other countries. And I think what we need to do is communicate that based on the facts and based on the analysis.
To me, discussions about possible political contagion here are similar to all the discussions about globalization that have occurred over the last few years. People for various reasons arguing that reduction in trade barriers, market principles are really not beneficial to the world economy, and many people trying to argue that that's not the case. That free trade is a way to reduce poverty and improve people's welfare. And I think because of events like this, we may have to have a response that pertains in particular to Argentina, and in particular to other countries in Latin America. But the arguments are very much the same. And that is to show as much as we can the facts, the reality that market principles, free trade, growth-oriented policies are good for people.
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Chairman BEREUTER. Next we'll go to the gentlelady from New York, Mrs. Maloney, Ms. Carson and Mr. Ferguson. The gentlelady from New York is recognized.
Mrs. MALONEY. What's going to happen next? We thought the IMF was going to give them a loan at $1.3 billion in December, and they have backed off from that. So what's next? We need the market reforms then they'll give them the loan? What's going to happen next? They obviously need help.
Mr. TAYLOR. That's true. The IMF in December, as part of its regular review of what was happening in Argentina, as in every program, judged that the fiscal targets in the program were not met and that on that basis did not give the next tranche, the next loan, the next installment, if you like. And so what's next is for Argentina to make the decisions, as they're beginning to do, to get their economy moving again so they can get into a program again.
So the next part is really playing out as it should in Buenos Aires and Argentina to take some decisions to improve growth in the Argentine economy.
Mrs. MALONEY. And what if they don't do that? What happens?
Mr. TAYLOR. Well, I very much hope that they do do that, and I don't want to think of any alternative. That's the alternative is to continue to have low growth and continue to have policies which are painful to people. There's a great opportunity to improve things, and I very much hope they
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Mrs. MALONEY. Why is there less contagion now? It used to be that something like this would happen and there was like just an international concern that it would destabilize more countries and really hurt individual investors and mutual funds and retirement plans.
Mr. TAYLOR. That's a very interesting question.
Mrs. MALONEY. Because I can remember Indonesia having similar problems, everyonesome of the Asian countries. But this one they're treating it very differently. So I'm wondering why you're thinking there's no contagion.
Mr. TAYLOR. Well, I think several things have happened. One is, there's much more analysis of what's going on in these markets than there was 3 years ago at the time you're referring to. So that investors themselves differentiate between countries' policies, good policies, bad policies. And they also differentiate between policies and external events that hit countries. And that's not just with respect to Argentina vis-a-vis other countries, it's with respect to all the markets.
I think that the U.S. and this Administration has tried to build on that change by commenting on it very early in our Administration, we commented on how contagion is changing. It's not automatic. It's more based on fundamentals. And in fact we were criticized quite a bit for that. But our purpose there was to communicate with the markets that we understood what was happening there and that our policies were going to reflect that. And I think that has helped to reduce the contagion as well by making our policies hopefully more predictable.
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Mrs. MALONEY. What is the role of the international financial institutions in this? I know at one point they threatened to leave the country when they were going to structure the conversion to pesos really to a disadvantage to their accounts. What role will they play in this in helping to
Mr. TAYLOR. Well, the international institutions have a role to play in emerging markets. I think their role can be improved in various ways, by greater transparencies and other things. But they do have an important role, not just the IMF, but the Inter-American Development Bank and the World Bank. And what they do, of course, not just with respect to Argentina, but with respect to other countries, is to provide loans.
That's what the IMF does, provide loans, to help bridge to better times, if you like. And I think they do that in the context of actions the countries take. So, for example, I just mentioned before, Turkey has taken some actions, on that basis they got loans hopefully to better times and things will improve and then the country can get off the IMF program and proceed with its policies independently.
Mrs. MALONEY. You mentioned earlier that they're not competitive in their exports, given their position as the third largest economy in South America, and that that's one of their problems. They're not able to generate their economy. Could you elaborate? What are they doing thatwhy aren't they competitive? Are their financial markets there controlling it too much, or what is happening? Running up the price? Or what's happening with their exports? They have a lot of things they could export. Why aren't they successful?
Page 39 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. TAYLOR. I think the main reason for the lack of so-called competitiveness recently was the change in the currency in Brazil and Europe, which basicallythere was a lot of trade particularly with Brazil, and the devaluation of the real.
Mrs. MALONEY. So it was really external actions?
Mr. TAYLOR. Yes. That's what that term means as I was using it. But it also means something internally about competition, and I think Argentina and many other countries could have ways to have their markets be more competitive. And ultimately, what's going to determine the degree of competitiveness for a country is how productive the country is. That is, how rapidly productivity increases. And that's a growth strategy, and that has to do with doing things, greater competition, less
Mrs. MALONEY. Are they implementing a growth strategy?
Mr. TAYLOR. Well, I hope so. I hope so.
Mrs. MALONEY. I thought Mr. Toomey's comments earlier were interesting. I was in Argentina in the mid-1990s and we met, the International Relations Committee with then-President Menem, and it was being touted as the economy to watch, the growth economy in South America, and that pegging the peso to the dollar had been a smart move, and this was the whole talk internationally and in Argentina at the time. And then to see complete reversal. And you just say that's increased uncontrolled spending that happened?
Chairman BEREUTER. The time of the gentlelady has expired. The gentleman may respond.
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Mr. TAYLOR. That was part of it. But I think the changes then were important. They had some very good effects. The problems now I think are not those changes, but moving away from those changes.
Chairman BEREUTER. The gentlelady from Indiana, Ms. Carson, is recognized.
Ms. CARSON. Mr. Chairman, I'd like to yield my time.
Chairman BEREUTER. The gentlelady may do that.
Mr. FRANK. Thank you.
Mr. Taylor, let me go back. Given the circumstances in which they were at the time, do you think the freeze was a good idea? The freeze on bank deposits.
Mr. TAYLOR. I think given that they were not going to make other changes at the time, yes. Other changes that could have been made.
Mr. FRANK. Like what?
Mr. TAYLOR. Well, they're of course now moving to a different exchange rate system. That would have been a possibility.
Page 41 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. FRANK. But, I thought they had movedhadn't they unpegged? They had unpegged, hadn't they, when they froze?
Mr. TAYLOR. They imposed the freeze before there was any move.
Mr. FRANK. OK. So you think if they had simply unpegged the peso and let it float?
Mr. TAYLOR. Well, as I was saying before, moving away from the peg toward solid dollarization or if you moved to a flexible
Mr. FRANK. Would they then have not had to do a freeze? If they had done the right currency policy, do you think the freeze would have been unnecessary?
Mr. TAYLOR. I think so, yes.
Mr. FRANK. And which would that have been, in your judgment? What would have been the best policy?
Mr. TAYLOR. Well, as I indicated, you can either
Mr. FRANK. Pick one. Are they equally good?
Mr. TAYLOR. It would depend on the circumstances at the time. But I'd say
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Mr. FRANK. This is not a hypothetical. This is like a real country. So we know the circumstances at the time. Argentina, 2001.
Mr. TAYLOR. Well, as I said before, and I believe thisI'm not dodging your questionthat decision depends very much on what the country's history is like and their politics.
Mr. FRANK. But we know that.
Mr. TAYLOR. From an economic perspective.
Mr. FRANK. Yes, but we know that. Again, this is not a hypothetical, Mr. Taylor. It's a real country. Argentina in 2001. And what would have been your recommendation?
Chairman BEREUTER. I think the gentleman understands your point. We'll just let him respond.
Mr. FRANK. He's not responding.
Chairman BEREUTER. He may. Give him a chance.
Mr. TAYLOR. I at that point in time thought that dollarization would have been good for Argentina.
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Mr. FRANK. I'm talking aboutbut couldn't dollarization, we're talking about last year when they had to get off dollarization.
Mr. TAYLOR. They were not in dollarization and they're not now. They're going in a different direction.
Mr. FRANK. You would have recommended that they move in 2001 to complete dollarization?
Mr. TAYLOR. I wasn't recommending that. Because, as I said, U.S. policy, it's for the country to choose. But, if you're asking my view
Mr. FRANK. That would have been your view?
Mr. TAYLOR. That would have been my view.
Mr. FRANK. That leads to another question, though, which is what would the short-term social impact have been of dollarization, do you believe? Would there have been any greater one way or the other?
Mr. TAYLOR. First let me say the political sideI won't address that, because it depends very much on what the politics in the country is. But from the economic side, dollarization can have advantages to a country. It removes the threat
Page 44 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. FRANK. I'm sorry, Mr. Chairman, if this bothers you. But we're not talking about a country. We're talking about Argentina in 2001. And the problem again, because I want to get back to this, is that is there is this problem which I think you are enlightening too easily and this is what we have to really deal with. I understand your tendency is to say if they had done better in the first place, the problem wouldn't have arisen. I agree with that. But almost always we only deal with the problems that have arisen. There are a number of countries that have done good things. We don't have hearings about them. We don't have to make policy about them. We're in the grief business. That's what you do and that's what we do.
The question is, given that these mistakes were made by people there, how do you deal with it? Because you acknowledge, you agree with Mr. Toomey that excessive government spending and deficits are part of the problem. The problem, though, is that what you said could be done to alleviate the short-term pain adds to a deficit. So that's the complex of tough issues I think you have to deal with.
If you're going to take steps that are remedial, but increase short-term pain, how do you do that? Or is that then an appropriate role for international aid? Should we come in and help them with money to alleviate short-term pain if we're convinced that they are doing this as part of a program that's going to provide some long-term advantage?
Mr. TAYLOR. I think that's the way that the programs are frequently put together. As I was saying, a bridge to better times to give them some resources.
Mr. FRANK. But then let's go back to the Meltzer Commission, because they made it in a different context. Should they be grants instead of loans? One of the arguments of the Meltzer Commission that did seem to me to have some plausibility would be that we use loans too often for people who are in terrible trouble when we should be doing grants. But differing with them, is that I don't think they were ready to put the additional resources into that that I think that calls for.
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But, should we have considered in a situation like Argentina if people are willing to adopt a policy that has long-term gain, short-term pain, should there be on our part and on the part of the international institutions a willingness to provide some money, perhaps through grants, to help them get over that?
Mr. TAYLOR. I think grants are an excellent way to proceed for very poor countries.
Mr. FRANK. So they're not Argentina?
Mr. TAYLOR. They're not Argentina.
Mr. FRANK. So you would not propose grants for Argentina?
Mr. TAYLOR. I think the loans are just fine for Argentina. The grants, however, for the poorest countries in the world
Mr. FRANK. I realize we're not talking about the poorest countries. Thank you, Mr. Chairman.
Chairman BEREUTER. The time of the gentlelady which was extended to Mr. Frank has expired. The gentleman from New Jersey, Mr. Ferguson.
Mr. FERGUSON. Thank you, Mr. Chairman. I appreciate, Mr. Chairman, your holding this hearing and I thank the witness, Mr. Taylor for being here. I appreciate your understanding. I wasn't here the whole time. I didn't hear some of the other questioning. I have read some of your testimony, but my apologies in advance if some of this is duplicative.
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Obviously the situation that we're dealing with Argentina is tragic in many ways. People there are experiencing very trying times. I appreciate what you have said and some of the principals that the Administration and the President laid out in terms of wanting to be friends and allies, to be there for our friends in their time of need.
But I think something you also said was to try to reduce the frequency of financial crises such as this in the future. And I think our reaction, and the actions that we take now in response to some of these crises and some of the actions taken by those in Argentina are gong to have a lot to do with avoiding these types of situations in the future, because not only do we want to make sure that this is a long-term and not simply a band-aid approach to helping Argentina during this time, but for their neighbors, for the rest of Latin American, and frankly, for the rest of the world are going to base their actions in some part looking at the reaction that we have to this situation.
I certainly don't want to take steps now to try and put a short-term solution on this situation and create additional long-term problems, and I'm sure you share this view. But that's kind of the mindset that I bring to this. And I certainly will not claim to be an expert on this situation. I certainly would not claim or pretend to know as much about the details of this situation as you do or perhaps as Mr. Frank does.
But I just have a couple of questions. What is your understanding of the measures taken by the Duhalde government against the United States companies that have invested billions of dollars in Argentina, such as folks in the electric and gas sector, the telecom sector, other sectors? What is your current assessment of the actions that have been taken?
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Mr. TAYLOR. What we've tried to do in talking with various firms is to emphasize to the Argentine government that it's important to treat all investors fairlyforeign investors, investors within their own country. And we'll continue to do that.
They're now going through this process of changing from dollars to pesos. It's part of a reform program. And that entails changing valuations, basically devaluation. And they're doing that in a way that tries to address the fact that if you change a denomination of a loan or a deposit, it has big impacts on individuals. It's going to sometimes force people into bankruptcy or to other dire situations.
So they're looking for ways to smooth that out. And ultimately, people are going to have to make adjustments to that. And I think what we can do and we are doing is emphasizing to them is to do this in a way that is fair and predictable and sensible, and when we see they're not going in that direction, we comment on it.
And I think there's an important reason to do that in addition to the ones that you're indicating, and that is, that's how they're going to have foreign investment and growth in the future.
Mr. FERGUSON. How do you feel, thoughI mean, we're talking about making sure that the actions that they're taking and the way that they are addressing the situation is fair and equitable. And I frankly have some concerns about what my understanding is the way that they're going about it. Do you share those concerns?
Page 48 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. TAYLOR. We've received many phone calls from people that are concerned about it. And we've in turn expressed those concerns. They of course have received many concerns as well. And what I'd say is, they're now working on these concerns and trying to take them into account. They haven't finished. A program is being developed, and how the pesofication works is still being developed.
So, again, what I would like to do is to continue to work with them, work with the private sector to give suggestions about how to make it work. It's not finalized at this point in time.
Mr. FERGUSON. Are we having conversations? Is Treasury having conversations with IMF right now about the nature of trying to ensure some protection for U.S. investors in particular? I'm thinking of the energy sector in particular. I mean, are we
Mr. TAYLOR. What we're having discussions with the private sector, with the government of Argentina, with the IMF is to argue that all investors should be treated fairlyforeign investors, U.S. investors, everyone else. So, yes, the answer to your question is yes, we are.
Mr. FERGUSON. Are we prepared to take actions with regard to that? I mean, are we prepared to insist that money being released to Argentina through the IMF is withheld until a fair process can be worked out or some agreements can be worked out? It's the estimation of a lot of folks that they're not going about it in a fair way.
Page 49 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. TAYLOR. I'd say yes, that is a factor in any advice we would give to the IMF about this, certainly.
Mr. FERGUSON. Where would you put it on a scale? I mean, are we very high?
Mr. TAYLOR. Yes.
Mr. FERGUSON. Finally, what is your understanding of the protections provided to U.S. investors under the Bilateral Investment Treaty with Argentina? And I'm thinking specifically about your understanding of any recourse that may be available to these companies, to any of these investors, particularly when we're talking about actions tantamount to exappropriation.
Chairman BEREUTER. The time of the gentleman has expired. The gentleman may respond.
Mr. TAYLOR. I want to make sure that that doesn't happen and work toward that. And if it does, then I'll try to answer your question when it happens if that's OK. But certainly, as I say, we're working very hard on that. We recognize the importance of the Bilateral Investment Treaty. We have lawyers who are looking at it carefully and policy experts, and it is a concern. But at this point the contacts we have both in the private sector and in the government say that they're working on things right now. Your questions to me and my responses I hope are helpful as well in terms of indicating how important we think this is.
Page 50 PREV PAGE TOP OF DOC Segment 1 Of 2 Mr. FERGUSON. Sure. I thank you, Mr. Chairman. I appreciate Mr. Taylor's testimony. And I would just reiterate that some of the concerns that I haveand you can see what I'm getting at through some of my questionsstill exist, and I'd be happy to continue to work with you and as we have questions in the future, if you could continue to be as cooperative as you have today, that would be great. Thank you.
Chairman BEREUTER. As a matter of fact, we'll permit the Members, by unanimous consent, to submit questions to the Secretary for the Treasury to respond to for all Members.
I'd like to begin a second round and focus really on two things. First of all, I appreciated your response about the reason we haven't had, fortunately, the degree of contagion that we might have expected or that we saw in the Asian financial crisis.
I am highly critical of the IMF's activities with respect to Thailand and Korea. I think they prescribed medicine that wasn't appropriate and caused additional problems and plunged those two countries into difficulties, but neither one were fiscal basket cases and the IMF is accustomed to dealing with fiscal basket cases.
I liked Mr. Toomey's comments about the structural and microeconomic changes that have been made in Argentina. But fiscal irresponsibility, it seems to me, is part of the problem. And much of the problems that Argentina has in my judgment are self-inflicted. And if you take a look at the fiscal policies or irresponsibility of the provinces in particular, and of course the national subsidy to them, there have been several economists that have written about the extraordinary corruption and flagrant expenditures by the provinces, and they just got bigger and bigger.
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Now hearing your comments about a middle type of peg which you think was not advantageous instead of a free-floating currency or a hard peg, do you think, if you know, the IMF loan extended in 1996, the IMF loan in 1996 and then extended in 1998, do you think the IMF gave a recommendation at that point about abandoning the type of dollar peg that they had in place?
Mr. TAYLOR. I just don't know the answer to that question.
Chairman BEREUTER. Do you think it would have been appropriate at that stage, or do you have an opinion on that?
Mr. TAYLOR. I really don't know the circumstances enough to answer it. My answer in general is the one I gave before, that there are these two sides which work well, and for a long time I've thought the one in the middle is questionable. And were I here at the time, I probably would have said that. But the circumstances are different.
Chairman BEREUTER. Thank you. We can go back and look at the speculation and what was the advice at the time, but of course we can't exactly find out because of lack of transparency.
The second point, I think Mr. Frank and perhaps another Member was headed this way. At least I want to convey the view that I think there are times when the patient is too weak to take the prescribed medicine, and that you need to try to restore some of the health of the patient. And Argentina is in that sick situation as Haiti was, for example, in the past, and the IMF imposed such a high degree of austerity measures that the political turmoil was just beyond their ability to cope with it.
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So it seems to me that we have an opportunity to permit them to acquire more debt, or there's some sort of grant program, and then the question might be, is that grant program in the IMF or is it in the World Bank and a regional development bank, Inter-American Development Bank, in this instance. It's always easier, I think, if it was a part of the IMF rather than a coordination between IFIs. But they don't have that history, as far as I know.
So do you want to say something about this issue that, in fact, the austerity measures have to be tempered in certain cases with some assistance to the people that are out of work and to the other people that are in some degree of destituteness or problem?
Mr. TAYLOR. I think that's correct, Mr. Chairman. And the philosophy behind the IMF's engagement with countries is to support that view, I believe, in the sense of giving more breathing time, more room to make adjustments and therefore use resources to alleviate pain that might occur otherwise as Mr. Frank was indicating.
The other IFIs, the World Bank and the IDB, can give more direct loans for the social sector. And of course, in the very poor countries, not Argentina, but give grants, as we're arguing for that purpose. The IDB and the World Bank have already indicated in the case of Argentina the willingness to provide loans for the social sectors which could definitely alleviate some of the pain that you're referring to.
So I think it is really part of the nature of the assistance that they can give to countries. In the case of reforms, there's this area where the reforms may be difficult, may require some extra social service payments or extra aid to people who are harmed by it. And they can provide in those circumstances.
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I think, just maybe add slightly to that, the concern that people sometimes have is that the loans and the support goes beyond that into more unsustainable things where there's nothing to bridge to, and then you get these series of problems that build up over time.
Chairman BEREUTER. The gentleman from Massachusetts.
Mr. FRANK. Thank you, Mr. Chairman. I'm going to pick up where you left off, because I think this is very important and I think we probably ought to acknowledge it. It's good that the international financial institutions are now doing this. Not too long ago they're doing the opposite. The IMF's response in situations like this, and this is one of the reasons it became controversial and many on this subcommittee were critical was in Asia and elsewhere in 1998, they were basically pressuring governments to do exactly the opposite; to cut back on those social measures which alleviate pain. And I think we should count that as a successful change in international public policy that the IMF now, and it's very good to hear you say that they have now reversed that and people understand that in the short term, some of these alleviation measures have to go forward.
As I said, again, unfortunately, if you go back in 1998 in Asia, they were prescribing exactly the wrong things. And I remember the specific prescriptions in Indonesia and Thailand and elsewhere that were exacerbating these kind of issues.
I was following very closely your debatenot your debate, your colloquy with Mr. Ferguson. Obviously people who lend should bear risk, but there are lot of tensions in this. One of the tensions is between telling all the foreign lenders that they're entirely on their own and don't come to me, and then saying, oh, by the way, it would be a good idea if you lent to those people. And I think if in fact we have a national policy of encouraging lending, then there is it seems to me some obligation to try and not bail them out completely, but to help. I do think this argues strongly for some form of international agreement dealing with what you do when you've got these kind of defaults.
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But, let me ask from the Treasury standpoint, is there any concernwe've got a couple of large financial institutions. One of them is obviously the major one in the State that I represent, that have been heavily exposed there largely for good reasons. Is there any concern in the Department that their exposure could become a problem for us here domestically?
Mr. TAYLOR. Well, we've looked at the numbers, talked to them. They obviously are very concerned with what's happening, and relating to the discussion with Mr. Ferguson, communicating to us how they see it.
Mr. FRANK. There's another bankruptcy bill and
Mr. TAYLOR. How they see it, and we listen and convey the concerns that we hear. But it's not something that is large enough to threaten their overall operations.
Mr. FRANK. OK. That's good to hear. But it does seem to me there's a public policy interest in their not being discouraged over and above there's no public policy interest in whether they make a profit or not. That's their deal.
Let me ask you one other set of questions. I know that the Administration had identified as a very high priority this free trade agreement with the Americas. It does seem to me that what's going on here is going to become more difficult there. In particular, what are the implications? I mean, clearly as you've said, one of the problems Argentina faced were the currency differences between Argentina and Brazil, the two large economies there, and the disparity in the value of the currencies have very significant impacts on trade. Does this mean that the currency question really has to be better dealt with as a prerequisite before you're going to get an agreement on an FTAA?
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Mr. TAYLOR. I think the FTAA can work well with various currency arrangements, as long as you don't get to these ones that are unsustainable. And if you think about what's happening in much of Latin America, it is moving into exchange rate systems that are more lasting, and either through dollarization, as has occurred in Ecuador, or through the flexible system that Chile has used for quite a while, a dozen years. They were one of the first to start this inflation targeting type of system with the flexible exchange rates, and now Brazil and Mexico.
Mr. FRANK. The question, though, was
Mr. TAYLOR. I think those all work quite well. When you think about
Mr. FRANK. I understand that. My concern is this. Is there going to be a reluctance on the part of some of the countries further to open their economies to trade if they are worried that currency differences might have more of an impact?
Mr. TAYLOR. I hope not. But I think an example is NAFTA. We have I think a very successful North American Free Trade Agreement. We have a fluctuating exchange rate with both Canada and with Mexico. None of this has happened with those.
Mr. FRANK. Do you think that Brazil and Argentina and the others think of themselves analogously to Canada, the U.S. and Mexico in that regard? I mean, my sense is that the hope may be father to the conclusion here. And it does seem to me that the instability and difficulty exacerbated by different, not just different exchange rates, but different exchange rate mechanisms, and that's contributed to this. And let me just ask you very simply, if you polled in Argentina a year ago about a FTAA and you polled today, would you think it would be about the same or do you think there might be more resistance?
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Mr. TAYLOR. Well, just guessing on my part, but I would say at least the same, maybe more favorable.
Mr. FRANK. You think the Argentine public is more favorable to an FTAA today?
Mr. TAYLOR. When I talk to my friends in Argentina, travel there, talk to them here, they are so positive about trade as a way to grow.
Mr. FRANK. Were any of your friends in Argentina out banging pots a couple of weeks ago?
Mr. FRANK. I mean, you know, there are friends and friends. Do you think that what's gone on is a good thing for the public support in Argentina for the FTAA?
Mr. TAYLOR. Well, I think the importance of FTAA is so important that we need to stress it further. In terms of what a particular person banging pots says, of course I don't know. But I think the genuine feeling is, is a recognition that more trade, in particular with the United States
Mr. FRANK. Well, I envy you from your perspective your optimism. It must make life very cheerful. Thank you.
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Chairman BEREUTER. Thank you. I think this is a question we may not want the Secretary to answer in open session.
Mr. FRANK. I seem to have come up with a lot of those.
Chairman BEREUTER. I think we need to conclude the hearing. But I do want to say that while I think that there are going to be a lot of attempts within Argentina to blame everybody else, including the United States, and perhaps there are problems with the IMF and the advice that they gave, perhaps there are, it's I think instructive to know that, unfortunately, Argentina, which was among the top ten countries in the world in per capita income at the turn of the 20th century, was one of the ten wealthiest countries in the world, a country that had relatively small amount of racial tension, a country that had a highly educated population for so long, has fallen to the problems that they have today for socio-economic reasons or political reasons.
So I do think we have a responsibility to look at the IMF, but I hope that, while we can provide some assistance as necessary to people that are really hurting there, by our international financial institutions, the country and the people need to look at themselves in the mirror, too, and that's my own view I just would offer at this point for whatever it's worth. But a country so rich, one of three countries in the world that have the best agricultural soil, a country that hasn't really focused on exports to a substantial extent, focusing on internal markets for the most part as compared to their neighbors, well, you can only help people so much unless they're willing to help themselves. And that's sad.
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I would ask unanimous consent before Mr. Frank leaves, the only Member, that subcommittee Members may be able to submit written questions to Dr. Taylor in the Treasury Department.
Dr. Taylor, thank you very much. I think it's been a very beneficial set of questions, and your testimony was very much appreciated and appropriate, in my judgment. And thank you very much.
Mr. TAYLOR. Thank you, Mr. Chairman.
Chairman BEREUTER. The hearing is adjourned.
[Whereupon, the hearing was adjourned.]
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