O'Neill's Folly: the IMF's recent Argentina bailout is good news for European bankers, bad news for U.S. policy, and a disaster for the Argentinean private sector.

The IMF's new $8 billion bailout makes Argentina's economic problems worse, not better. Nor does the bailout "buy time" for Argentina, as some optimists claim. It buys time only for some of Argentina's major foreign creditors.

The major beneficiaries to emerge from the bailout are the European megabanks that hold about 75 percent of the country's foreign debt. The minor beneficiary is the Argentinean political class, whose policies are ruining the economy. The losers are investors, both domestic and foreign, and the average working Argentine. The net effect of the IMF's bailout is twofold: increased moral hazard and increased austerity. The country has been stripped of any conceivable means for restoring economic growth. Increased moral hazard will be keeping foreign investors away more than ever. Increased austerity is crushing the domestic private sector.

However, there are two badly mistaken arguments that are used to blur this clear picture. The first is the conceit that the austerity will break up the pork barrels of the political class, thereby freeing resources. The second is the pious hope that this will result in an "improved profile of the foreign debt," lower interest rates, and thus open the way to economic growth. None of this will happen. Here's why:

The increased austerity is being used by the present coalition government to wreck the rival pork barrels of the opposition Peronist party, not necessarily to reduce the role of the state for the benefit of the private sector. In fact, the major part of the austerity program is to intensify tax collection from the reeling private sector. As for the hope that lower interest rates will automatically kick-start economic growth: Yes, a restructuring of the debt (even if disguised as "debt profile improvement") could lower interest rates. But if Japan and the entire Asia-Pacific region have taught us anything in the last two years, it is that low interest rates--even zero interest rates--cannot launch a recovery if the problems are structural.

Argentina's structural problem remains intact after the IMF bailout. It is a statist economy mired in protectionism, waste, and inefficiency. Protectionism is promoted by the right wing of the political class, waste by the left wing, and inefficiency by both. At the present moment, the right wing (Cavallo) is struggling to restore the state's solvency, and the left wing (Alfonsin) is fighting equally hard to preserve the state's patronage base. The Peronists--who are excluded from the levers of central power but are a major force in provincial governments--are printing local currencies and drifting toward replacing the Argentine republic with a confederation of provinces.

What is destructive about Cavallo's austerity is the fact that he is willing to wreck the private sector to salvage the public sector's solvency. In Argentina, "public sector solvency" means the ability of the political class to borrow from its European bankers in perpetuity. Anyone who has done the numbers knows that Argentina will have to go to the international banks and/or credit markets again next year to meet its obligations. To do so, the state must restore its solvency before that not-too-distant date. It is attempting to do so at the expense of the private sector. The IMF's bailout, when stripped of rationalizations and embellishments, is nothing more than the means to finance this attempt to loot Argentina's private sector.

The disgraceful aspect of this affair is that the United States has been maneuvered into taking the lead in promoting such a disastrous policy. Some folks at the Treasury, especially Undersecretary John Taylor, believe they have found a "new approach" for dealing with emerging market debt problems without compromising the interests of taxpaying American "plumbers and carpenters," as Treasury Secretary Paul O'Neill put it. The magic trick is supposed to be a stealth debt restructuring (camouflaged under the name of "improved debt profile") that will be "market-based" and "voluntary." Supposedly, this will be done with "international guarantees" and/or new collateral (i.e., U.S. Treasury bonds that Argentina would purchase with IMF money).

Not mentioned is the central fact that the IMF will get money from taxpaying American "plumbers and carpenters" and give it to Argentina, which will use it to buy U.S. Treasuries and then give these solid Treasuries to its European creditors in return for retiring their worthless, high-interest Argentinean bonds.

The European creditors are happy, the Argentinean political class breaks out the champagne, and the American "plumbers and carpenters" are ripped off a few billion dollars. If the "plumbers and carpenters" ever get angry and push ever comes to shove in Washington, the Bush administration will naively argue that there were other, greater strategic considerations at work: the need to preserve alliances with friends in the Western Hemisphere and avoid provoking anti-American sentiments in Latin America. Nonsense. We did not help Argentina. We helped Argentina's venal political elite to squeeze Argentina's private sector. Our friends were Argentina's private businessmen and workers who were clamoring for dollarization and outright restructuring of the public debt. Dollarization and debt restructuring would have crushed the political class and would have freed up the productive powers of the private sector.

Dollarization and debt restructuring were also the initial objectives of the American negotiators. When they abandoned these objectives, they gave up on building goodwill, friendship, and alliances with Argentina's businessmen and workers. Now, in the aftermath of the IMF bailout, the United States looks like the instigators of the austerity havoc Argentina faces.

The United States cannot afford to repeat this debacle. It is not in the country's national security interest or its economic interest. The U.S. economy that emerged in the decade of the 90's has as its natural allies the private sectors of the world's various national economies. As its natural enemies, it has their government sectors. This order of national interests was turned upside down in the IMF's Argentina bailout. In the roaring 90's, the American economy represented a model of the superiority of private initiative over government dirigisme, and a hope that such a model can be built anywhere. If we continue with our current Argentina policy, the people of the world will see America as an ally of right-wing political elites that want to squeeze dry the entrepreneurial classes in order to salvage the solvency of bankrupt states.

For emerging market debt as a whole, the Argentine bailout has enhanced moral hazard. As a result, all emerging market debt, estimated at $1.3 trillion, becomes more vulnerable.

Ranked by vulnerability, the largest debtors are Turkey, Brazil, South Korea, and Mexico. They account for a total of $435 billion, of which $120 billion comes due between now and March 2003. In Turkey, signs of a new unraveling have begun. Brazil's amortization schedule will probably become explosive next year, when it will have become evident that the Argentina bailout was a flop. South Korea and Mexico, because of their closer connection to the U.S. economy, are somewhat less vulnerable, but if the Bush administration's policy of favoring right-wing statists over the private sector continues, their vulnerability will go up.

If the Argentina debacle is repeated in Turkey, Brazil, South Korea, or Mexico, the United States will end up losing the priceless goodwill of these countries' emerging entrepreneurial classes, the backbone of their private sectors. If South Korea and Mexico seem less vulnerable at the moment, it is because Washington in the recent past came down squarely in favor of their emerging or entrepreneurs and nascent private sectors and against their bloated state sectors. As a result, both Korea and Mexico are in the middle of intense political struggles to defeat the still-powerful remnants of state dirigisme. In Turkey and Brazil, however, this struggle has not yet been joined. Given that it is Turkey and Brazil that are likely to be the next candidates for bailouts, the temptation will be high for Washington to follow the path of least resistance and repeat the Argentina debacle. If this happens, then what was initially a mistake--the Argentine bailout--will be enshrined as national policy. This would jeopardize the hard-won victories of the private sector in South Korea and Mexico.

It would probably lead as well to negative domestic consequences for the United States in ways that cannot yet be predicted: A mere two days after the Argentina bailout, some senior European commentators already began talking about the possible "Europeanization" of the United States.

Criton M. Zoakos is President of Leto Research, Inc., an economic research firm in Ft. Lee, NJ.