Financier George Soros was the first to put in print what many in the financial world knew about Argentina's default on its debt. In contrast to corporate borrowers, writes Soros, "sovereign states do not provide any tangible security; the only security the lender has is the pain that the borrower will suffer if it defaults. That is why the private sector has been so strenuously opposed to any measure that would reduce the pain […]."

Of course Soros, writing in his latest book, On Globalization, was not advocating the course of pain and suffering that is now being inflicted on Argentina. If it were up to him, there would be an international bankruptcy procedure that could resolve Argentina's debt crisis in an orderly way, and allow the country to make a fresh start.
But Argentina's international creditors are not so forgiving, and they are determined to get their pound of flesh. In the 19th century, this might have been accomplished through gunboat diplomacy. Today, the world is more civilized: we have the International Monetary Fund.

The Fund has been negotiating with the government of Argentina since President Eduardo Duhalde took office in January. It has demanded harsh austerity conditions, including cuts in public spending amounting to about 4 percent of Argentina's output. For comparison, imagine cutting public spending in the US by $400 billion in the middle of a present-day Great Depression.

Argentina's government has surrendered to the IMF on this and almost all of its other demands. But the IMF won't seem to take yes for an answer. And as Roberto Frenkel, Director of the Bank of the Province of Buenos Aires noted this week, it will be extremely difficult to stabilize the country's currency without some positive signal from the Fund.

Frankel also suspects that the Fund is punishing Argentina in order to discourage other countries from defaulting on their debt. "This is discussed openly in financial circles," he said at a recent conference in New York. "Of course the argument is made that this is for the benefit of developing countries as a whole. In other words, if Argentina defaults and is not punished, then lending to developing countries will drop."

This is called "maintaining the integrity of the international financial system," and it is part of the IMF's mission. It is not so benign as the picture that most people have of the IMF as running some sort of international rescue operation.

In early April the Fund announced that it is only willing to lend Argentina enough money to service its debt to the IMF and other multilateral lenders such as the World Bank. This is the worst of all worlds: Argentina will be required to implement the Fund's destructive conditions, which will almost certainly prolong the depression; and they get no new money for their pain.

The main constraint on the IMF is that Washington--to whom the IMF answers--may get nervous about causing a political meltdown in Argentina (the economic meltdown has already happened). There is a risk of backlash throughout Latin America, where populism is making a comeback after two decades in which per capita income has barely grown.

The cruelty of this punishment will not be overlooked in Latin America, as it has been in the United States. Presidents Fernando Henrique Cardoso of Brazil and Alejandro Toledo of Peru have publicly criticized the IMF for its treatment of Argentina -- an unusual break with protocol for heads of state.

Outside of official Washington, most people can see the profound injustice of holding Argentina accountable for failed policies that were the joint project of the IMF and the Argentine government. The IMF loaded Argentina with enormous, un-payable debt in order to support a currency regime -- the fixed exchange rate of one peso for one dollar - that was completely unworkable. And the Fund's sister institution, the World Bank, supported the privatization of Argentina's social security system in 1994. By last year, the lost revenues (plus accumulated interest) due to this single privati-zation were as large as the entire government budget deficit.

Nobel-prize winning economist Joseph Stiglitz recently suggested that Argentina might be better off without an IMF agreement, rather than accepting the Fund's austerity conditions and a deepening depression. This is certainly possible. During the Asian financial crisis in 1998, the government of Malaysia refused an IMF agreement and went its own way. Malaysia used currency controls, rather than the sky-high interest rates in neighboring Indonesia, to stabilize its exchange rate. This move would have been forbidden by the IMF; but according the World Bank's post-mortem on the crisis, Malaysia fared better than the other hard-hit countries (Indonesia, South Korea, Thailand, and the Philippines) in terms of output lost as a result of the crisis.

But many Argentine political observers fear that the Duhalde government, not having been elected and without a strong popular base of support, would have difficulty exercising the strong leadership required to say no the IMF. On the other hand, the country does have some important economic factors on its side. Argentina is running a trade surplus, and - not counting interest payments - the central government budget is not far out of balance. So if the government had a moratorium on its debt service, there would be little need for outside financing. In other words, unlike many countries that end up living beyond their means and need to borrow externally while they "adjust" (hence the origin of the term, "structural adjustment"), Argentina doesn't really need much more from abroad than a suspension of interest payments. As bad as the economic meltdown is, the country has the capability to recover fairly quickly on the basis of its own resources.

"The IMF led a whole series of mistakes, from exchange rate policy, to fiscal policy, to the privatizations, that culminated in disaster [in Argentina]," notes Stiglitz. But the Fund's economists cannot see the irony in punishing millions of poor and working Argentines in order to enforce market discipline, while the IMF expects to get back every dollar it loaned, with interest.