It must be nice to work for the US Treasury, what with its rose-colored, all-is-well view of the global economy. Trouble in Argentina? No problem.
Turmoil in Turkey? No worries. New cracks in Asia? Big deal.
President George W. Bush's Treasury team thinks silly Wall Street traders are whipping themselves into a frenzy over nothing.
The ongoing plunge in emerging-market debt and currency markets isn't a crisis, they suggest, but a figment of financiers' imaginations. In short, Treasury Secretary Paul O'Neill and his international team have proclaimed that not only is the global economy sound, but that financial contagion is something of a myth.
"Exaggerating the possibility of contagion leads to too frequent intervention because, in effect, we convince ourselves we don't have a choice," O'Neill said. "If we do not have to worry about contagion, it is going to be a lot easier to say, `you brought this situation on yourself in spite of the best possible advice and we are not going to bail you out.'"
It's hard to quibble with O'Neill's concern that institutions like the International Monetary Fund and World Bank are too quick to throw money at troubled economies. But the suggestion that financial contagion is a non-issue in today's global financial system is insensitive at best, and reckless, at worst.
"We're obviously seeing contagion from Argentina to Brazil, and from day-to-day other markets are being hit," IMF Deputy Managing Director Stanley Fischer said. "The last thing anyone should be is complacent," about Argentina's problems, especially since the world's largest economies are struggling in an economic slowdown.
O'Neill might consider taking his all-we-have-to-fear-is-fear-itself view to folks in Southeast Asia, Russia and parts of Latin America who've experienced a major drop in living standards in recent years. It's doubtful any of them believe financial contagion is a mere fairy tale. As currencies plunged and interest rates surged, many households were set back a decade or more financially. These folks will tell you that contagion is not a cover story concocted to justify excessive bailout packages, as O'Neill suggests.
Remember that when Thailand devalued the baht four years ago, hardly anyone knew the event would stir up the worst global financial crisis in a half a century. That's just what happened, however, which explains why recent hiccups in Argentina and Turkey have investors losing sleep. If Argentina defaults on debt or devalues the peso, investors figure, emerging markets near and far would get slammed as well. The worry is that once the turmoil hits bigger economies, it could be 1997 all over again.
"The situation remains very, very close to the edge of the abyss," says Anne Mills, senior currency economist Brown Brothers Harriman & Co in New York.
The White House isn't convinced. It sure would be nice to think markets could be calmed with a little positive thinking, as Treasury officials seem to think. But try as they may, policy makers can no longer ignore the financial turmoil popping up from Argentina to Turkey to South Africa. Developing economies are fragile at a time when larger ones are troubled as well. In a world of numerous weak links, there are no obvious growth locomotives.
O'Neill's all-will-be-well-soon position makes one wonder who, if anyone, in this administration is keeping tabs on the international economy. It also increases the risk that the US will lose its clout in the global economic arena. If Washington won't take a leadership role, someone else will.
"The international slowdown is unarguable; there is no zone which has been spared," said French Finance Minister Laurent Fabius last week. "Today, in view of the globalization of the economy, the nature of our economies, the rate of contagion is much faster and it is more sensitive than in the past."
To O'Neill, Fabius must seem like a colossal worry wart. Yet O'Neill may not be as dismissive of contagion risks as he might want us to think. Following the July 7 meeting of the Group of Seven industrial nations, O'Neill said he and his G7 counterparts "expressed their own hope that this expectation [for a rebound in US growth] will be fulfilled because as we've all noted, we're very much tied together these days." The Bush Administration has supported a US$13.4 billion IMF aid package for Argentina and US$19 billion for Turkey. O'Neill is trying to have things both ways -- downplaying risks of contagion, while working to avoid it.
If O'Neill is set on changing the subject away from financial contagion, why didn't he do the same for the US six months ago? The Treasury chief and the rest of the Bush administration spent the early part of 2001 talking down the US economy with an enthusiasm rarely seen in modern history. Rather than working to foster investor confidence in the economy -- which is, after all, a finance minister's job -- O'Neill warned that trouble was afoot.
It was Vice President Dick Cheney who first tossed the word "recession" on to the national stage. As finance minister, it was up to O'Neill to silence Cheney and the others. He didn't, and in the days that followed the press ran banner headlines reporting the White House's chatter about downside risks in the economy. The episode was akin to yelling "Fire!" in a crowded theater and the administration did it to win support for its US$1.35 trillion tax cut.
By the same token, O'Neill's outright dismissal of financial contagion risk could have side effects he hasn't thought of. One risk is that some investors will take the Treasury secretary at his word and be lulled into complacency about the state of the global economy. If Argentina takes Brazil down with it -- as looks increasingly possible -- and sets off an Asian-crisis-like domino effect, investors will think twice about trusting advice from the US Treasury.
"Contagion concerns regarding Argentina have taken their toll on peripheral currencies -- including the dollar-blocs,'' says Shahab Jalinoos, a currency strategist at UBS Warburg LLC in London.
Warning signs are flashing. The Brazilian real hit an all-time low versus the US dollar last week as concern grew about an Argentine default. Mexico -- an emerging-market success story -- also has seen its currency lose ground along with those of Chile and Peru. Emerging market bond yields, meanwhile, are on the rise.
Investors also are hunting for liquidity; many have been rushing into the safety of US Treasury debt.
Maybe O'Neill's what-global-crisis? strategy is merely the flipside of his attempts earlier in the year to make the US economy seem worse off than it was. If investors turn a blind eye to today's financial turmoil, tomorrow they may not cause the kinds of massive capital outflows that can precipitate crises.
Trouble is, psychology does play a role in financial crises, but so do poor economic policies that lead to currency devaluations and defaults. The risk of contagion looms large.
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