[Senate Hearing 107-]
[From the U.S. Government Publishing Office]



                                                     S. Hrg. 107 - 1017


                     INSTABILITY IN LATIN AMERICA:
                        UNITED STATES POLICY AND
                THE ROLE OF THE INTERNATIONAL COMMUNITY

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                    INTERNATIONAL TRADE AND FINANCE

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                                   ON

        UNITED STATES POLICY AND THE ROLE OF THE INTERNATIONAL 
 FINANCIAL COMMUNITY CONCERNING ECONOMIC INSTABILITY IN LATIN AMERICA, 
 PROSPECTS FOR ECONOMIC AND PRODUCTIVITY GROWTH, AND THE INTERNATIONAL 
                             MONETARY FUND

                               __________

                            OCTOBER 16, 2002

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs



90-623              U.S. GOVERNMENT PRINTING OFFICE
                            WASHINGTON : 2003
____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512ï¿½091800  
Fax: (202) 512ï¿½092250 Mail: Stop SSOP, Washington, DC 20402ï¿½090001


            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  PAUL S. SARBANES, Maryland, Chairman

CHRISTOPHER J. DODD, Connecticut     PHIL GRAMM, Texas
TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         WAYNE ALLARD, Colorado
EVAN BAYH, Indiana                   MICHAEL B. ENZI, Wyoming
ZELL MILLER, Georgia                 CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware           RICK SANTORUM, Pennsylvania
DEBBIE STABENOW, Michigan            JIM BUNNING, Kentucky
JON S. CORZINE, New Jersey           MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii              JOHN ENSIGN, Nevada

           Steven B. Harris, Staff Director and Chief Counsel

                Linda L. Lord, Republican Staff Director

                  Martin J. Gruenberg, Senior Counsel

                Thomas Loo, Republican Senior Economist

      Amy F. Dunathan, Republican Senior Professional Staff Member

   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator

                       George E. Whittle, Editor

                                 ______

            Subcommittee on International Trade and Finance

                      EVAN BAYH, Indiana, Chairman

                 CHUCK HAGEL, Nebraska, Ranking Member

ZELL MILLER, Georgia                 MICHAEL B. ENZI, Wyoming
TIM JOHNSON, South Dakota            MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii

                Catherine Cruz Wojtasik, Staff Director

              Daniel M. Archer, Republican Staff Director

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                      WEDNESDAY, OCTOBER 16, 2002

                                                                   Page

Opening statement of Senator Bayh................................     1

Opening statement of Senator Sarbanes............................    14

                               WITNESSES

John B. Taylor, Under Secretary for International Affairs, U.S. 
  Department
  of the Treasury................................................     3
    Prepared statement...........................................    42

Daniel K. Tarullo, Professor of Law, Georgetown University Law 
  Center.........................................................    29
    Prepared statement...........................................    46

Michael Mussa, Ph.D., Senior Fellow, Institute for International 
  Economics......................................................    31
    Prepared statement...........................................    51

Scott A. Otteman, Director of International Trade Policy, 
  National Association
  of Manufacturers...............................................    33
    Prepared statement...........................................    67

                                 (iii)

 
                     INSTABILITY IN LATIN AMERICA:
                  UNITED STATES POLICY AND THE ROLE OF
                      THE INTERNATIONAL COMMUNITY

                              ----------                              


                      WEDNESDAY, OCTOBER 16, 2002

                               U.S. Senate,
  Committee on Banking, Housing, and Urban Affairs,
           Subcommittee on International Trade and Finance,
                                                    Washington, DC.

    The Subcommittee met at 10:05 a.m., in room SD-538 of the 
Dirksen Senate Office Building, Senator Evan Bayh (Chairman of 
the Subcommittee) presiding.

             OPENING STATEMENT OF SENATOR EVAN BAYH

    Senator Bayh. Good morning, everyone. I appreciate your 
being here on a rainy morning and your interest in this 
important issue.
    I am going to make a brief opening statement and then, 
Secretary Taylor, we look forward to hearing from you, as we do 
the other panelists.
    First, let me formally call this hearing before the 
Subcommittee on International Trade and Finance to order.
    Chairman Sarbanes will be joining us at some point in the 
next 45 minutes or so. And I know that the Ranking Member, 
Senator Hagel, would also want to welcome you and the other 
panelists. The Secretary has been good enough to be with us 
before and I welcome you back to the Subcommittee once again.
    The Subcommittee is meeting today to hear testimony 
regarding the instability in Latin America and its relationship 
to United States policy and the role of the international 
community.
    Our witnesses will include John Taylor, the Under Secretary 
of the Treasury for International Affairs. As Under Secretary 
for International Affairs, Mr. Taylor serves as the principal 
advisor to the Treasury Secretary on international issues, and 
leads development of policies in the area of international 
finance and economics. Mr. Taylor will explain the United 
States' international economic policy and related issues.
    Mr. Taylor, thank you again for joining us.
    Our second panel includes three very distinguished 
individuals. Professor Daniel K. Tarullo, Professor of Law at 
the Georgetown University Law Center. Professor Tarullo teaches 
in the areas of international economic regulation, 
international law, and banking law. From 1993 to 1998, he was 
successively Assistant Secretary of State for Economic and 
Business Affairs, Deputy Assistant to the President for 
Economic Policy, and Assistant to the President for 
International Economic Policy.
    Mr. Tarullo will discuss how the previous Administration 
successfully addressed the international financial crises of 
the 1990's, as well as examine what the United States' policy 
should be in the future.
    Mr. Tarullo, thank you for joining us this morning.
    Also with us is Dr. Michael Mussa, Senior Fellow, Institute 
for International Economics.
    Prior to joining the IIE, Dr. Mussa served as Economic 
Counselor and Director of the Department of Research at the 
International Monetary Fund from 1991 to 2001, a very active 
decade, where he was responsible for advising the management of 
the Fund and the Fund's executive board on broad issues of 
economic policy and for providing analysis of ongoing 
developments in the world economy.
    Dr. Mussa, who is joining us for the second time, will 
testify about the effectiveness of the International Monetary 
Fund and the rest of the international community in dealing 
with Latin American economic instability.
    Dr. Mussa, thank you for joining us. He has not arrived 
yet.
    I was reading some very interesting testimony of our 
witnesses, Mr. Taylor, yours, Mr. Otteman, as well as Mr. 
Tarullo's, last night. Dr. Mussa actually contained a reference 
to his family cat in his testimony, which is a first in my 
experience, but I will explain that later in my questions to 
the doctor. It was actually amusing and had some relevance to 
our discussion today.
    Finally, Scott Otteman--I hope I am pronouncing that 
correctly--Scott is with us from the National Association of 
Manufacturers. Frank Vargo was originally going to be with us, 
but was otherwise delayed. So, we send him our regards. Scott 
is the Director of International Trade Policy for the National 
Association of Manufacturers, which is the largest multi-
industry trade association in the United States.
    As NAM's Trade Policy Director, Scott is responsible for 
monitoring and analyzing all U.S. trade negotiations and 
disputes, including the World Trade Organization and its 
recently launched Doha Development Agenda, the Free Trade Area 
of the Americas negotiations, and ongoing talks with Chile and 
Singapore.
    In addition, he works closely with legislative offices on 
Capitol Hill to advance the top trade priorities of 
manufacturers, such as the enactment of Presidential Trade 
Promotion Authority.
    Scott will explain the real impact of instability in Latin 
America on the American business community and to employment 
and economic growth in this country, and will offer 
recommendations from the manufacturing sector's point of view 
about what can be done in Latin America.
    Scott, thank you for joining us this morning as well.
    A brief statement of my own and then, Mr. Secretary, we 
will get right to you.
    America has a strong interest in global economic stability 
and growth. At the microeconomic level, more American jobs are 
dependent upon demand from abroad than ever before.
    Scott, I think we will hear some from you in that regard.
    At the macro level, a greater percentage of our gross 
domestic product is derived from exports than at any time in 
our recent past, and at a time of sluggish domestic growth, 
foreign markets are more important than ever before.
    At the geo-political level, a development abroad is also 
very important. Democracy and international security are more 
likely to flourish when economies are stable and prosperity is 
expanding.
    There is currently a debate about how best to advance 
America's interests. Some argue for intervention to achieve 
greater stability within distressed nations and to limit the 
spread of contagion to other nations. Others argue that 
intervention creates moral hazard and that the unfettered 
discipline of markets offers the best long-term guarantee of 
stability.
    This hearing will explore several questions related to this 
debate.
    What are the principles that guide U.S. support for 
economic intervention? Are they solely economic? If so, what 
are they? Do geo-political factors play a role? If so, how do 
we prioritize them? Is the political sustainability of the 
economic policy prescriptions that we offer as a result of 
intervention considered? If so, how so?
    Has the policy of the Administration changed from that 
originally espoused, to that actually implemented? In this 
regard, we will pay particular attention to the cases of 
Turkey, Brazil, Argentina, Uruguay, and Pakistan and compare 
them to the Argentine experience, once a poster boy for 
economic reform, now considered by many to be a pariah.
    The Committee does this out of the conviction that 
transparent analysis consistently applied promotes certainty, 
which in turn limits the likelihood of both contagion and moral 
hazard resulting from miscalculations by debtors and creditors 
alike.
    Finally, the hearing will explore alternative mechanisms 
for debt relief, sovereign debt restructuring mechanisms, so-
called SDRM's, and also, collective action clauses, so-called 
CAC's. What would the benefits of these mechanisms be? What are 
the potential detriments? What are the barriers to their 
adoption? And finally, are they mutually exclusive, or are they 
potentially complementary?
    To explore all of these questions, we are very grateful for 
the presence of the Under Secretary, Mr. Taylor. And thank you, 
you have been very generous with your time to the Committee in 
the past. So much has happened since you were here last 
February. I appreciate your coming back with your full agenda. 
We look forward to hearing from you.

                  STATEMENT OF JOHN B. TAYLOR

           UNDER SECRETARY FOR INTERNATIONAL AFFAIRS

                U.S. DEPARTMENT OF THE TREASURY

    Mr. Taylor. Thank you very much, Mr. Chairman. And thanks 
for inviting me to this hearing.
    We have written testimony which I would like to put into 
the record and make some opening remarks.
    Senator Bayh. It will be included.
    Mr. Taylor. Thank you.
    Strengthening our ties with Latin America and encouraging 
economic growth in the region are central to President Bush's 
overall economic agenda, not only because we want to help our 
neighbors, but because we realize that stability and growth in 
the region is in our interest as well. The United States 
benefits greatly from strong neighbors and we risk losses when 
Latin America goes into economic turmoil.
    When I testified before this Committee last February, 
economic and financial conditions throughout much of Latin 
America were improving, with the exception of Argentina. Growth 
seemed to be picking up after the slowdown of last year 
associated with the slowdown throughout the world economy. 
However, conditions throughout the region have become more 
difficult since last February. Risks have risen and economic 
growth this year seems to be coming closer to zero than to 
positive territory. Clearly, raising economic growth in the 
region must remain a high priority for the United States and 
for the countries of the region.
    However, considering Latin America as a single entity 
overlooks some important differences between countries. For 
example, Chile has very strong economic policies. It is ranked 
among the most open, competitive, and economically stable 
countries in Latin America. It grew by nearly 7 percent in the 
1990's, well above the average of the region. Similarly, 
Mexico, after experiencing nearly 70 percent inflation and 
near-zero growth throughout the 1980's, grew at an average of 5 
percent in the late 1990's, and its growth is picking up now, 
along with the United States.
    I would say that El Salvador stands out among those 
countries that have made tremendous strides by pursuing sound 
economic policies and emphasizing private-sector growth. 
Bolivia, Peru, and Colombia are now working to implement a 
strong policy mix that I believe will enhance stability and 
raise economic growth.
    I would particularly note that President Bolinos in 
Nicaragua and President Maduro in Honduras are taking very 
aggressive actions to deal with corruption in their countries, 
which has been an impediment to economic growth.
    As you know, Brazil has experienced significant turbulence 
relating to election uncertainties in the last few months, 
despite strong economic policies and efforts to keep inflation 
low and deal with fiscal policy reform. For Uruguay, events in 
neighboring Argentina have contributed to significant 
difficulties, especially this past summer. I believe the 
Uruguayan authorities, working in cooperation with the United 
States and the international community, have been able to deal 
with these problems and there are improvements taking place 
right now.
    Regarding Argentina, which I testified about just last 
February, I believe that in the last few months, we are 
beginning to see some stabilization following the significant 
deterioration in 2000 and 2001, the freeze on the bank 
deposits, the end of dollar-peso con-
vertability, and the default on its debt. As we speak, 
Argentina and the IMF are working to conclude an agreement 
which could create a short-term program to help begin economic 
growth in the economy by establishing a clear monetary and 
fiscal framework.
    I would also like, Mr. Chairman, to comment briefly on one 
of the points you made in your opening remarks, and that is the 
nature of contagion in emerging markets generally.
    When you look at the impact of the crisis in Russia in 
1998, you see an impact in many, many parts of the world far 
and unrelated to Russia, including Latin America and Asia. 
Interest rate spreads increased at the time of that default in 
a way that many people commented on referred to the concept of 
contagion. In contrast, the events that occurred around the 
world at the time of the crisis in Argentina culminating last 
December were completely different. In fact, interest rates on 
sovereign debt showed no such increase as occurred in 1998 in 
the case of Russia.
    I believe this represents a marked change in the nature of 
contagion between countries.
    Just for example, and to be sure, risk spreads did not 
increase in Asia at that time. They did not increase in Europe. 
And through much of this year, after the default in Argentina, 
there was no 
impact in Latin America as well. Recent events are related to 
the direct connectedness between Argentina and Uruguay and 
election uncertainties in Brazil.
    So it seems to us that in recent years, investors have 
become more skilled at differentiating between countries, 
between good policies and bad policies and focusing on 
fundamental economic assessments. And that has changed the 
nature of contagion. We have sought to promote further 
evolution in this direction by emphasizing that our policy 
decisions will not be based on unfounded claims of contagion.
    Of course, we recognize that there are important direct 
links between countries, as I have already indicated in the 
case of Uruguay and Argentina, but I would call that 
interconnectedness, direct interconnectedness, rather than 
contagion itself.
    So going into the future, what we need to do to raise 
economic growth in the region and work with the countries is to 
focus on raising productivity growth. Part of our overall 
international economic agenda has stressed productivity growth 
throughout the world, and that stress applies to Latin America 
with great importance. I am optimistic that productivity growth 
in Latin America could improve greatly. The truth is that 
productivity growth was only 0.7 percent in Latin America in 
the 1990's. It was 1.7 percent in the developed countries in 
the world more generally and 2.7 percent in the East Asian 
developing countries. So a 1 or 2 percent gain would make a 
huge difference in living standards and the reduction in 
poverty throughout the region.
    The first step to raising productivity is to seek to 
implement appropriate policies that encourage productivity. And 
here, President Bush has focused on three types of policies 
that I think are important and apply to any country. The first 
is ruling justly. That is, to follow the rule of law, concern 
about enforceable contracts, and to be sure about the 
importance of corruption and eliminating it and reducing it. 
The second is to invest in people. That is, to keep the human 
capital high by strong education and strong health. And the 
third is to encourage economic freedom. That is, to reduce 
barriers to trade throughout the world, as well as the informal 
barriers to trade that exist within countries because of 
regulations.
    There is a long list of policy initiatives that we are 
engaged in with Latin America. I mentioned some of them in my 
testimony. The reform of the North American Development Bank, 
an institution that has not been working well since it was 
created in 1993, is an initiative that Mexico and the United 
States have been engaged in for the last year and a half, have 
made real progress and legislation to carry out those reforms 
is now in the Congress.
    The Partnership for Prosperity intiative with Mexico is 
something that President Bush and President Fox have instructed 
the economic officials in both countries to work on, 
emphasizing private-sector growth.
    An effort to work harder to have remittances going from the 
many immigrants in the United States back home to countries in 
Latin America to make it cheaper is another initiative. 
Relative to the size of the economies, especially in Central 
America, there is a huge amount of money that is sent home from 
immigrants to their families. I was in an elementary school in 
El Salvador this summer and asked the children in the class how 
many had relatives in the United States, and it was virtually 
95 percent. And in El Salvador, approximately 25 to 30 percent 
of their income is in the form of remittances from the United 
States.
    We can help these countries prosper more if we make it 
easier for immigrants to remit funds back to these countries.
    As you know, we are pursuing a free trade agreement with 
Chile right now. We hope to conclude that as soon as possible, 
now that the Trade Promotion Authority has been passed. The 
President has notified the Congress about initiating talks on a 
free trade agreement with Central American countries, and we 
are pursuing a free trade agreement with the Americas as a 
whole.
    We are supporting the Inter-American Development Bank, the 
World Bank, and the IMF to be of assistance, focusing on good 
policies. As I indicated, the President has delineated and 
focusing on measurable results to make sure that the funds are 
used effectively. Our negotiations with the World Bank's IDA 
program, in the past, replenishment has forged new ways to make 
these funds more effective through grants and through an 
insistence on measurable results.
    So, in conclusion, Mr. Chairman, I think that in spite of 
the recent turbulence in some countries in Latin America, that 
the region has enormous potential and that we can look forward, 
with the right policies, to better economic prospects in the 
region in the 
future.
    Thank you, Mr. Chairman.
    Senator Bayh. Thank you, Mr. Secretary.
    I am grateful for your time. Let me say at the beginning, I 
admire your optimism, and I understand the importance not to 
gratuitously undermine confidence.
    I am reminded of someone in a much different context who 
came to visit me the other day and gave me a definition of a 
pessimist I had not head before. He said: ``A pessimist is an 
optimist who has access to better information.''
    [Laughter.]
    There is some information out there that would suggest that 
it may be a difficult road, but I understand the importance to 
look at the glass as being half full and to do what we can to 
buttress confidence and take your comments in that light.
    Let me begin by asking you something, Mr. Secretary, in 
your prepared testimony, about the size of interventions that 
the IMF has conducted and that we have supported. I am sure you 
are aware--the President made statements back during the 
campaign that we would not be supporting the kind of large 
interventions we had in the past. The Secretary made some 
comments to that effect in his testimony at his confirmation 
hearings. There have been other statements. You are familiar 
with this.
    And then in your testimony today, you say, ``We are working 
to increase discipline in terms of access to IMF resources that 
will 
reduce the size of IMF packages . . .'' in order to ``. . . 
reduce the risk of moral hazard.''
    That has been pretty much a consistent explanation of the 
policy throughout. Let me list some of the interventions that 
have taken place and just ask for your reaction.
    With regard to Brazil, I think there was a $15 billion IMF 
program for Brazil equal to roughly four times the normal 
annual IMF access limit committed in September 2001.
    With regard to Turkey, a further $12 billion increase in 
IMF support was committed to Turkey in February 2002, raising 
the total support to $31 billion, a record for the IMF up to 
that time in absolute amount, in support relative to IMF quota, 
and as a share of the country's GDP.
    With regard to Uruguay, given their size, a relatively 
large $1\1/2\ billion augmentation of the IMF support in June 
2002, and a further increase in official support, raising total 
committed support to $3.8 billion in August 2002, setting a new 
record for the ratio of official support to GDP.
    And finally, the $30 billion augmentation of IMF support 
for Brazil committed in September of this year, just a couple 
of months ago, setting a new all-time record for the absolute 
level of IMF support committed to a single country.
    Given our desire to try and reduce the size of these 
interventions, how do we explain the series of relatively large 
interventions that we have, in fact, supported over the last 
couple of years?
    And again, I say this not to be critical. I am just trying 
to explore perhaps--there is either a disconnect between our 
stated policy and our actual implemented policy, or perhaps 
there has been an evolution in policy to take into account 
changed circumstances.
    Can you react to the list of interventions in light of the 
policy pronouncements?
    Mr. Taylor. Of course. Thank you very much for the 
question.
    I do not believe that there has been a change in our policy 
with respect to where we intend to go, which is to try to 
address some problems that existed in the emerging markets and 
still exist. And those problems are that the flows of capital 
to the markets diminished greatly in the late-1990's. The flow 
of capital from 1992 to 1997, on the private side, based on net 
calculations, was over $150 billion a year in that period.
    In 1998, 1999, and 2000, the flows dropped to less than $50 
billion. Some people refer to that as a sudden stop. There were 
quite a few crises that occurred in many countries around the 
world in the mid- to late-1990's. And interest rate spreads 
remain still very high and it is a burden on the taxpayers in 
these countries.
    So these are the kinds of problems that we want to address 
with our emerging market policy. And part of that is, as you 
say, Mr. Chairman, to reduce the size of packages and to make 
the packages more interpretable, clearer to the private sector, 
to the official sector and to the countries themselves.
    Two of the countries that you mentioned--Turkey and 
Argentina--were in crisis as we started in the Administration. 
And we worked hard to improve the situation. I believe Turkey, 
with the proposals that we put through, the prior conditions 
that Turkey was in, has greatly improved. Inflation is down and 
economic growth is up.
    The program that we dealt with when Uruguay was, I think, a 
classic focus on significant monetary issues, exactly the 
issues that the IMF was designed to handle. Uruguayan 
authorities had good policies in place. They were hit hard by 
the shock in Argentina.
    We developed a surgical, I would put it, well-focused plan 
to deal with the problem in their banking sector. The size of 
that program was because it focused on keeping the payment 
system going, and I think it was very effective.
    Now with respect to the overall size questions that you 
mentioned, one of the important principles that we have tried 
to follow and indicated at the beginning was that in order to 
begin reducing the size of packages and to make the size 
clearer to people in the market, we wanted to have the focus be 
on the IMF, on the international financial institutions, rather 
than provide additional support and additional access from 
bilateral contributors such as the United States, the G7, and 
the G10.
    The case of Turkey was the first place that we established 
this principle. And that program did not have large bilateral, 
large-scale, medium-term support from the developed countries. 
That is, in fact, why the program was a little larger from the 
IMF. The overall program was smaller.
    Similarly, in Brazil, the program that was just put through 
the IMF, it was smaller than the program in 1998, which was 
approximately $42 billion. As you mentioned, this program was 
$30 billion.
    The reason is that the bilateral side of this program was 
not there as it was earlier. The additional contributions from 
countries around the world, which has the same notion and the 
same concept of funds was not there, so the overall program was 
smaller.
    And with respect to Uruguay, the only kind of bilateral 
support that was there was a short-term bridge loan from the 
United States which was very important to get those banks open 
as soon as possible.
    I believe if you look at this general strategy, we are 
adhering to it. We are focusing on the IMF, which has, after 
all, a limited overall supply of resources. That puts a budget 
constraint on their operations. It puts accountability where it 
belongs, on the people who are working closely on the programs. 
We think it is working.
    The last thing that I would say about this, Senator, is I 
think the strategy that we are taking is one that has to be 
implemented gradually. We would like to reduce the problems 
that I mentioned at the beginning. It does require changes in 
policy. But to change that overnight, to suddenly say there is 
going to be a stop of funds without any notification, I think 
can be disruptive.
    As an example of that, let me just finish with this problem 
that has arisen in Argentina. Argentina had a crisis in the 
fall of 2000, an IMF program. When we came in, they were off 
that program. So, we said, rather than make a sudden change, 
let us give a 
waiver in the spring of 2001.
    In the summer of 2001, they were beginning to run into 
difficulties because of a bank run, people pulling money out of 
the banks. As a result, we decided in that context that an 
augmentation of the program would be clear, but with a clear 
emphasis that the debt was beginning to be a problem and needed 
to be addressed and we focused the nature of our program on 
that.
    Then, finally, in December of last year, after a lot of 
indications of what we would do when the situation became 
clearly unsus-
tainable, and when the program was off track, we supported the 
IMF decision to stop the support to Argentina because the 
policies at that point in time did not merit it.
    It seems to me that that is very consistent with the 
strategy that we would like to take, and that is to support 
countries that are doing the good things and have the good 
policies, but to hold back in unsustainable situations and hold 
back in situations where the countries are not following good 
policies. And we are trying to adhere to that as closely as we 
can.
    Senator Bayh. Well, let us use that as an example, Mr. 
Taylor. You have outlined here a fairly pragmatic approach with 
regard to Argentina. You intervene when it seems that there is 
some hope for accomplishing some good, and you do not when it 
clearly would just be throwing good money after bad. That seems 
to be a sensible approach to things.
    I would like your reaction to--and I say this not to be 
critical, but just as an observation that there has been an 
evolution in a more sensible direction. But it is my 
observation that perhaps we have made a shift from an 
ideologically based policy to a more pragmatic policy. You 
mentioned the change in capital flows was one of the reasons 
that we supported some of these interventions.
    It would seem to me that our policy might be described as, 
we would prefer not to support these large interventions, but 
if the circumstances justify it, we will do so. Is that a fair 
commentary?
    Mr. Taylor. I hope that we would be pragmatic in policy 
decisions and maintaining a set of principles, such as the one 
I indicated, trying to limit access, just trying to be more 
predictable.
    By the way, trying to deal with this restructuring issue, 
which you want to come back to, on the sovereign debt side. 
Trying to deal with crisis prevention. Adhere to those 
principles. But there is no but about it. In practice, 
decisions come to us and we have to do the right thing at that 
time.
    I believe that what we have done here is be guided by these 
principles. We are always going to be pragmatic. These are very 
important issues. They affect many people's lives. And I 
believe that the strategy of gradually moving in a direction to 
address the problems that exist is the right approach to take.
    I believe it has always been pragmatic, Senator.
    Senator Bayh. Thank you, Mr. Secretary. Let me ask about a 
couple of specific instances, one I believe that you just 
addressed. The first is the $8 billion augmentation for 
Argentina in August 2001. Everything in hindsight appears to be 
clear. With the benefit of hindsight, was the decision to 
support augmentation a mistake?
    Mr. Taylor. I do not believe so, Senator, no, it was not.
    Senator Bayh. Do you think the money will ever be repaid?
    Mr. Taylor. I certainly expect the money to be repaid.
    The decisions at that time, as I indicated, had to do with 
Argentina in a crisis, had been in a crisis for several years. 
And what we would like to do at that point is ultimately get 
them back on a strong path, with strong economic growth, help 
the people of the country and the region.
    And to do that, we thought at that point in time, the 
augmentation was appropriate. Of that augmentation $3 billion, 
by the way, was dedicated to trying to move ahead on the debt, 
a debt swap. Five billion dollars was dedicated directly to the 
bank problem that they had in time. So, I think it was designed 
in an appropriate way.
    I would also say, Senator, in terms of moving gradually 
toward a policy of limiting access, this seemed to me important 
to do. After all, there was very little contagion from 
Argentina at that time. Moving gradually I think was part of 
that.
    When the event actually took place last December, when the 
IMF stopped support, it did not have the impact that the 
Russian default had in 1998. There was, as I said in my opening 
remarks, very little ripple effect, not even in other parts of 
the world, but not much in Latin America at the time, either. 
Uruguay was right next door and we dealt with that problem.
    I think if you look at the policy and you see the impacts, 
it was important to move gradually in the decision of last 
December, of last August, as well as the decision to have a 
waiver in April 2001, I think was correct.
    I sincerely wish that Argentina did not have to go through 
the problems they went through this year. That is a tragedy. 
But in terms of signaling our behavior and our changes, I think 
we did the right thing.
    Senator Bayh. Thank you. Let me return to that for just one 
moment. And the reason I do so is not to play gotcha, or say, 
well, it was a mistake, although I must say that, I guess from 
my vantage point, I can afford to be a little more pessimistic 
about the outcome of these things than can you. But the reason 
I return to it is for the benefit of decisions going forward in 
an attempt to learn from that decision, if perhaps it has not 
turned out quite as we had hoped, and what can that do to 
inform us about making future decisions when confronted with 
circumstances somewhat similar to those--we hope there won't be 
too many similar to those--but future sets of circumstances.
    What have we learned from the Argentine experience? Where 
did we go wrong? Why did they deteriorate so dramatically? What 
did we not know at the time the augmentation was made that we 
know now, and how can we apply that to future circumstances?
    Mr. Taylor. Argentina made some very important reforms in 
the early 1990's--controlling spending, on the tax side and on 
the convertability side, got the inflation down by huge 
amounts, and the economy grew very successfully in the early-
1990's through the mid-1990's.
    About that time, Argentina started to move back on those 
policies, on the spending side, on the tax side, and 
ultimately, began to raise questions about their convertability 
law.
    And when those actions began to take place, the economy 
started to deteriorate. There were shocks from abroad, to be 
sure, as all countries are subject to, but the policies were 
not conducive to economic growth and economic growth faltered.
    I would say that that is, to me, the main lesson of 
Argentina, is that countries----
    Senator Bayh. It happened so precipitously after our 
decision in August 2001. What didn't we know? Was there just 
not transparency of information coming out of Argentina? We 
augmented and then, pretty quickly, they headed downhill.
    Mr. Taylor. No, I would not characterize it that way at 
all. What happened is, in the period of 1998, 2000, 2001, 
growth was getting slower, problems were arising. There were 
two or three periods where sovereign debt spreads increased by 
quite a bit. The debt was growing, raising questions about 
sustainability.
    We tried to work with them, as we are continuing to work 
with the economic officials in the country to help them with 
the policies. We gave them the support. I do not think that it 
was a mistake to do that support last August, and I think it 
was effective in the sense of keeping the contagion down 
throughout the region and throughout the world.
    It was an assistance there. And that is one of the things 
that I think we would like to try to do, is when there is a 
damage effect, such as in the case of Uruguay, try to deal with 
that contagion, which we did.
    But we do not really see, as I see, the contagion effects 
that existed in the past and I think the policies are one 
reason for that.
    To me, the lesson that I would stress most of all is, when 
a country has demonstrable problems with the sustainability of 
its debt, and where it chooses to address those problems by 
restructuring, there should be a more orderly way for the 
country to do so. And that is one of the reasons why we are 
pursuing some reforms of this sovereign debt restructuring 
process. And you mentioned two approaches that are out there.
    I think that if we can make those changes, it will be 
easier to adhere to the access limits that we would like to 
adhere to, because there will be a route for countries to take 
if they get into this very unfortunate situation of 
sustainability.
    I believe countries should not get to that state. It is a 
mistake for countries to get to that state. They should take 
every effort they can not to get into the state of 
unsustainability. But when it happens, we have to find a way to 
make it more orderly. And that is really the main lesson, I 
think, from these recent crises.
    In 1996, the international community suggested collective 
action clauses. If we had started in 1996 on introducing 
collective action clauses into these debt instruments, the 
world would be completely changed. The emerging market debt 
would have changed, and I think in a very constructive way.
    What we are trying to do now is let us get back to this. It 
is at the top of our agenda. Let us get the collective action 
clauses working with the private sector and the emerging 
markets themselves into these debts, so when these very 
unfortunate events happen, it is a smoother, a more orderly 
process.
    Senator Bayh. As you know, that is on our agenda today as 
well, and I do think that this debate about where we go forward 
is an important part of this process, just as we attempt to 
learn from past decisions.
    However, if I could just offer an unsolicited opinion about 
one of the other lessons that we learned, and that is why I 
alluded to it in my comments.
    The implementation of sound economic policies and the 
political sustainability of those actions in the country in 
question, it seems to me, are inextricable. And perhaps we did 
not have as great an understanding of the internal political 
dynamic and problems in Argentina that we now have, and their 
ability to really make the hard decisions and to not just talk 
about them and propose them, but really implement them, not 
only at the Federal, but also at the provincial level, is 
something that I think we know a lot more about now than we did 
then.
    So perhaps a focus on some greater political analysis, 
combined with economic analysis, is something that we could 
benefit from going forward. Is that a fair observation?
    Mr. Taylor. I agree with that. We can improve our economic 
analysis, but we also can improve our political analysis.
    I would say, though, and this is something that President 
Bush has emphasized, that the ownership of the policies by the 
countries really should be their responsibility.
    It is so important for whatever policy is taken, that it be 
owned by the country, that in a democracy, the people have 
chosen that policy, rather than have it be imposed from the 
outside, whether from the United States, the IMF, or whatever 
organization.
    And President Bush has emphasized this ownership and 
accountability on the part of countries. We are working toward 
that. I believe the Millennium Challenge Account emphasis on 
good policies in the countries and aid will go to the countries 
that are following good policies, and it will not go to 
countries for economic development if they are not following 
the good policies.
    It is a new approach which I am excited about. It goes in 
the direction of making the policies that will cause growth 
more likely, and I think that there is still tremendous 
evidence that countries like Chile, who are following good 
policies, are succeeding, and countries which have chosen, 
unfortunately, poorer policies, like Argentina in the late 
1990's, are not succeeding.
    And that is the lesson and we need to encourage that. But 
the countries themselves have to make the decisions. It is 
their political system. It is their country. And we just want 
to emphasize that as much as we can.
    Senator Bayh. Thank you, Mr. Secretary.
    I mentioned there were two examples. We touched upon the 
Argentine one. I would now like to ask you about Brazil. And 
again, it is in the context of--welcome, Chairman Sarbanes.
    We are joined by the Chairman of the Banking Committee, 
Senator Sarbanes.
    Thank you, Paul. I would be happy to interrupt my 
questioning here.
    Senator Sarbanes. No, no. Thank you.
    Senator Bayh. I would touch briefly upon the topic of 
Brazil. And the point I wanted to make, which I alluded to in 
my opening comments again, is the importance of transparent 
policy consistently applied, it seems to me leads to better 
outcomes in the long run.
    If we were making statements about discouraging people from 
an expectation that there were going to be significant 
interventions because of our preference not to do so, that is a 
consistent point of view. Favoring interventions is also a 
consistent point of view. When we waffle around in the middle, 
we can run into some difficulties. I would just like to mention 
Brazil as an example. And I say this not to criticize the 
Secretary, but I will just get right to the point.
    We were discouraging the belief that there would be 
significant interventions. Comments, perhaps offhandedly, later 
softened, were made that had the effect of perhaps undermining 
confidence in Brazil, which then we decide that we need to 
intervene, and because of lower confidence, the size of the 
intervention is greater, or the cost is greater than it would 
have been otherwise. So do you want to comment upon the case in 
Brazil and some of the comments that were made, the effect on 
confidence? I think the ultimate package, although you 
mentioned the absence of bilateral assistance, at least at the 
time, it struck observers as being about twice the size that 
the market had been expecting. I am kind of wondering if that 
was in some ways related to the damaged confidence in the 
markets that existed at that time.
    Mr. Taylor. No, the size of the package and the profile was 
something that the Brazilian officials had been discussing and 
had thought about with the IMF.
    In fact, the profile is important to mention. The lion's 
share of the funds would be disbursed after the new 
administration begins in office in this program. And that was 
one of the ideas that the Brazilians focused on, that if the 
different candidates in the election could agree to a certain 
common denominator with respect to a sound fiscal policy, and 
agree to continue that after the election, then the funds would 
continue to be distributed. So the size and the timing were 
based on the circumstances in Brazil.
    I would also say, Senator, you mentioned this in your 
introductory remarks, but Brazil also came to the international 
community in the summer of 2001, when Argentina was undergoing 
the crisis that we just talked about.
    Their IMF program from 1998, which I said was $42 billion, 
including the augmentation from other sources, was coming to an 
end at the end of last year. And they asked for a new program, 
considerably smaller than the old one, but it made sense at the 
time.
    Senator Bayh. I guess my question goes to our own policy 
and the consistency of our approach.
    Mr. Taylor. Okay.
    Senator Bayh. Which, as I said, we seem to be evolving to 
the right direction.
    Let me just read you the quote, and again, I say this not 
to be personally critical of the Treasury Secretary. This is at 
the time Brazil is very much in play in the markets: ``Throwing 
U.S. taxpayers' money at the political uncertainty in Brazil 
doesn't seem brilliant to me.''
    That is a direct quote from the Secretary. And you can 
imagine how the markets received this. When we turn around and 
do exactly that, when we describe it as not a brilliant idea, 
perhaps that has some effect on the kind of steps that we have 
to take.
    Mr. Taylor. Well, I think the Secretary's comments, I do 
not know the context of those, exactly. There was clearly a lot 
of discussion about the uncertainty relating to the election.
    As I say, right at that point in time, we had had an 
augmentation of a new program from Brazil, so people 
interpreted that in that context. It may not come to the 
conclusions or raise the questions that you are raising.
    I believe that we should be as clear as possible to the 
markets about what our intentions are. You cannot lay out every 
decision and every contingency into the future. But you can try 
to be clear.
    I think that is what we are trying to do. I mentioned 
moving gradually to a new type of policy, trying to reduce the 
number of crisis countries. When something comes up like 
Uruguay, let us be clear why we are doing that. It is because 
they are so close to Argentina and we can narrow in and help 
them in this particular case, and come as close to the 
principles as we can.
    I hope I am answering your question satisfactorily, 
Senator.
    Senator Bayh. You are doing an admirable job, Mr. Taylor, 
under somewhat difficult circumstances.
    I guess I would sum up and ask the Chairman if, at this 
point, he would like to comment. But as I said, it seems to me 
that it is a logical approach to try and limit interventions, 
or it is a logical approach to favor interventions.
    We seem to now be gravitating toward a pragmatic third 
approach, which there are also underpinnings for if we set 
objective criteria transparently for meeting interventions.
    My point is that when we seem to swing from one to the 
other in the context of a particular intervention, there are 
costs to that, if you undermine confidence and you have what 
might appear to some to be an inconsistent application of 
policy. That is the only point I am trying to make. We should 
arrive at an approach, stick with it consistently. And it seems 
to me that that is the best way to move forward.
    Mr. Taylor. I agree with that. We will try to continue to 
work to be clear about what the principles are, what the 
problems are we are trying to solve, and adhering to those as 
best we can in the real-world environment that we face.
    Senator Bayh. Thank you, Mr. Secretary.
    Chairman Sarbanes.

             STATEMENT OF SENATOR PAUL S. SARBANES

    Senator Sarbanes. Thank you very much, Senator Bayh.
    First of all, I want to commend Senator Bayh, who chairs 
our International Trade and Finance Subcommittee, for holding 
today's hearing.
    Oversight of the conduct of international economic policy 
is a vital function and significant priority of this Committee. 
In fact, earlier this year, Senator Bayh chaired an oversight 
hearing with Secretary Taylor, as a matter of fact, on the 
economic problems confronting Argentina. Earlier, I had chaired 
a hearing of the Full Committee with Secretary O'Neill on the 
Treasury Department's Report to Congress on International 
Economic and Exchange Rate Policy. This morning's hearing 
carries on that oversight effort.
    I think it is fair to say that the United States has a very 
large stake in economic and political stability in Latin 
America.
    Further, the response by the United States and the 
international financial institutions to the problems of Latin 
America has significant implications, I believe, for the 
conduct of policy elsewhere in the world.
    In that regard, I have considerable concern over the way 
the Administration has responded to the problems in Latin 
America. That point is made rather forcefully by some of the 
witnesses who will come on the second panel.
    In fact, I am going to depart from usual protocol because I 
have not figured out an answer to this yet myself.
    As a matter of tradition, we put the Administration's 
witness on first. Then we hear from the panel, which usually is 
a balanced panel. But we get, on occasion, some sharp 
criticisms of the Administration's policy. Of course, by that 
time, the Administration's witness has testified, answered 
questions, and left. So the panelists are coming, as it were, 
after the fact. And we never get the two meeting.
    What I am going to do this morning is quote from some of 
what the panelists will tell us subsequent to the Secretary's 
departure and ask the Secretary to respond to that.
    Michael Mussa, who is the Senior Fellow at the Institute 
for International Economics, and was formerly the Economic 
Counselor and Director of the Department of Research at the 
IMF, says in his oral statement here to the Subcommittee this 
morning:

    I see a fundamental inconsistency between the U.S. 
Administration's rhetorical opposition to large-scale 
assistance packages to aid in emerging market financial crises 
and the actual practice of supporting a remarkable number of 
such packages.
    Indeed, despite its continuing rhetorical opposition, I 
count at least six occasions when the Administration has 
endorsed large-scale assistance packages during the past 20 
months.
    I believe that the glaring inconsistency between these 
facts and the Administration's rhetoric has done significant 
damage. Other countries have been confused and in some cases, 
offended, by the confusion in U.S. policy.
    In particular, officials in Brazil and in much of Latin 
America took umbrage at Secretary O'Neill's remarks last 
summer, suggesting that further official support for Brazil 
would be a waste of money that would be opposed by the U.S. 
Government, a policy statement that was soon disowned and then 
reversed.
    For the international community to play a constructive role 
in the resolution of emerging market financial crises, it needs 
to behave in an understandable and reasonably predictable 
manner. Otherwise, other key actors will not be able to 
function in a sensible manner.
    Constructive leadership from the United States is essential 
in defining the responsible role that is to be played by the 
official community. Recently, such leadership has been lacking.

    What is your response to that?
    Mr. Taylor. Senator, when you look at the decisions that we 
have made since the start of the Administration, I believe they 
are consistent with a set of principles that we have been 
trying to 
adhere to. Those principles are designed to deal with some real 
problems that have existed in the emerging markets since the 
mid- to late-1990's. The first of them is the significant drop 
of private capital flows to the markets. The second is a large 
number of crises that came in the 1990's compared to the 1980's 
and earlier periods. And third is continuing high interest 
rates on debt that emerging market countries have to pay.
    Our strategy is designed to deal with those by working at 
better crisis prevention, at trying to deal with the reform of 
the debt restructuring process, at being clearer and more 
predictable about 
access, and I will come back to that in a minute. And that 
strategy is something that we have articulated in testimony and 
in speeches. It is one that we make clear to the markets when 
we talk to people in the markets and to countries when they 
talk to us. In particular, many countries in Latin America.
    Why might one think that there are inconsistencies? One 
possibility is part of our endeavor to reduce and make the 
access policy clear is to focus more attention on the IMF and 
make the IMF accountable for the decisions.
    We are doing that by saying, whenever we can, we would like 
to have significant, large-scale, medium-term support from the 
bilateral community, from the United States, from the G7, not 
part of these packages. That basically puts more focus on the 
IMF.
    Now, as a result of that, the IMF part of the package could 
be larger. But the overall package will be smaller. And so, I 
would just give you the examples of this.
    The 1998 package for Brazil was $42 billion. The package 
that you are raising now as an inconsistency, quoting Dr. 
Mussa, was $30 billion.
    For what it is worth, and I think the size of the recent 
one is appropriate and the timing is appropriate, it is 
smaller.
    The case of Turkey, there were requests for the United 
States to go along to augment the IMF's contributions. We 
thought it was important not to do that, in the effort of being 
more predictable.
    What is the market to expect where sometimes the official 
sector beyond the IMF is in and sometimes they are not? If they 
realize it is the IMF, then it is an effort to be more 
predictable.
    So it was the IMF and the international financial 
institutions in the case of Turkey.
    Senator Sarbanes. Let us take the Brazil example.
    Mr. Taylor. I think there is a consistency, Senator.
    Senator Sarbanes. Well, I am having a hard time finding it. 
Let us take the Brazil example.
    On June 21, shortly after Brazil's government tapped a $10 
billion line of credit with the IMF, Secretary O'Neill 
suggested that the Bush Administration would block additional 
IMF loans to Brazil saying, and I think that Senator Bayh 
quoted this before: ``Throwing the U.S. taxpayers' money at a 
political uncertainty in Brazil doesn't seem brilliant to me.''
    He added, ``The situation there is driven by politics. It 
is not driven by economic conditions.''
    This is in The Wall Street Journal, June 24.
    Later that same day, Secretary O'Neill issued a statement 
clarifying his remarks, in which he asserted that: ``The 
Brazilian government is implementing the right economic 
policies to address the current difficulties.''
    Now, what is the policy thread that runs through that? I am 
having a hard time finding it.
    Mr. Taylor. These are, I take it, quotes from the same day 
you are referring to? I believe they are from the same day.
    Senator Sarbanes. Yes.
    Mr. Taylor. It seems to me, Senator, when you take a quote 
out of context, you know very well that you run the danger of 
misinterpreting. And it is important, as Secretary O'Neill did 
on that day, to provide the context for his earlier quote, and 
he did that, and I think the context made it clear that, just 
as I said before, our policy is to support countries who are 
following good economic policies to create strong private-
sector productivity growth. And the message from the quotes 
that you mentioned is that.
    Senator Sarbanes. You think I have taken them out of 
context?
    Mr. Taylor. Senator, I do not know if you have----
    Senator Sarbanes. Did the Brazilian government take them 
out of context in terms of its very strong reaction, reaction 
so strong--let me read you the statement that the Secretary put 
out on June 21. ``To clarify my earlier comments, the Brazilian 
government is implementing the right economic policies to 
address the current difficulties.''
    This is after he has said that throwing U.S. taxpayers' 
money to political uncertainty in Brazil doesn't seem brilliant 
to me.
    Because of these policies, we have consistently supported 
Brazil, including through its current IMF program, launched 
last summer, and last week's $10 billion drawing on that 
program. Brazil has not requested new funds and its economic 
fundamentals are strong.
    Brazil is a critical regional and global partner of the 
United States. It seems to me that the Secretary is 
backtracking pretty fast in that statement.
    Mr. Taylor. The policy, as articulated by the Secretary and 
the Administration is to support countries with good policies.
    Senator Bayh. Mr. Taylor, forgive me for interrupting. I 
was just pointing out to the Chairman, most importantly, the 
markets reacted adversely to those comments. So, they were 
looking at it in the context of the overall statement and 
apparently they reached the conclusion that something was 
amiss.
    Mr. Taylor. This is a question about the market reaction to 
particular statements by Secretary O'Neill?
    Senator Bayh. No, just that the markets reacted to the 
comment that it was not a brilliant idea to engage in the 
intervention and then the clarification had to be issued to 
help calm the impression that the markets had reached.
    Senator Sarbanes. Well, I take it that you are telling me 
that this was all part of a thought-out strategy. In other 
words, it was part of a thought-out program that the Secretary 
should make these remarks, that you should get the kind of 
reaction that you got from Brazil, and then the Secretary 
should issue his clarifying statement. That was all thought 
out, that was part of the program?
    Mr. Taylor. I did not say that, Senator.
    Senator Sarbanes. Oh, okay. What are you saying?
    Mr. Taylor. I am saying that we have a policy with respect 
to our economic support and it is to support countries that are 
following good economic policies. We have been clear about 
that. The Secretary has been clear about that. The President 
has been clear about that.
    Senator Sarbanes. Well, you say that you are not going to 
do these big programs and then you do them every time. I do not 
understand what is happening.
    Let me carry the Brazil thing a step further.
    In July, Secretary O'Neill told Fox News Sunday that aid 
will be forthcoming only after Latin American nations can 
assure that the aid: ``Doesn't just go out of the country to 
Swiss bank accounts, upsetting financial markets and setting 
off a diplomatic tiff with Brazil.''
    And in another turn-around, on August 1, the Secretary 
released a statement saying: ``I continue to favor support for 
Brazil and other nations that take appropriate policy steps to 
build sound, sustainable, and growing economies.''
    Just 1 week later, the IMF announced the $30 billion loan 
for Brazil. The Treasury Department was quick to issue a 
statement to express its support and even its pleasure at the 
announcement.
    Which obviously leads to the question, in light of all 
these contradicting statements, what was the strategy with 
regard to Brazil?
    Mr. Taylor. The strategy is the same as our strategy for 
any country. And that is to support countries who are following 
good economic policies, to stress the ownership of those 
policies.
    Brazil, under the leadership of the Central Bank President, 
Arminio Fraga, has instituted a good program to get inflation 
down from the horrible hyper-inflation levels that Brazil 
experienced. They have adopted a fiscal responsibility law to 
deal with the provinces. The President has instituted great 
improvements in the social sectors in the economy. So it is a 
good set of policies and we are supportive of that.
    The question about consistency it seems to me is answered 
by looking at what we have done with respect to countries, the 
overall strategy that we have put forth in testimony, in 
speeches, where it is all laid out. And I think if you spend 
all the time taking excerpts from remarks, that that is not the 
way to look and evaluate a policy.
    Senator Sarbanes. Mr. Secretary, I am not taking excerpts 
from remarks, in the sense that these were remarks that were 
made that created a major reaction. The reaction was so strong, 
that it then led the Secretary to issue ``clarifying 
statements.'' There was tremendous confusion about what the 
Administration's policy was, and is. And I think that is a 
problem.
    Now you can sit at the table and say, well, you are just 
picking a quote--and if there had been no reaction to it, if 
there had been no consequences flowing from that, that would be 
a reasonable point for you to make--why are you pulling this 
little quote out and using it? But I am focusing on the quote 
because it created major reaction.
    Let me quote you what Dan Tarullo, who is also on the next 
panel, says in his statement.
    And I apologize, Mr. Chairman.
    Senator Bayh. No, no. Please continue, Chairman Sarbanes.
    My comment, Mr. Secretary, was, I understand you have to 
defend the Secretary. My comment was that I think it is 
incorrect to in any way imply that the Chairman was taking 
quotes out of context because the market had an adverse 
reaction to the totality of the comments.
    Senator Sarbanes. Let me just quote Tarullo.
    ``The voice of a U.S. economic official is itself an 
important instrument of policy. A consistent, measured, and 
coherent voice establishes credibility, reassures market 
actors, and enhances U.S. 
economic leadership. The absence of such a voice has just the 
opposite set of consequences. While I think it unfair to hold 
the Administration responsible for all the financial problems 
faced by emerging markets . . .''--and I would insert, I would 
certainly agree with that--``. . . I think it legitimate to 
criticize the lack of consistency, coherence, and restraint in 
its statements and actions.''
    Now, I think that is right on point.
    Mr. Taylor. Well, Senator, I do not think it is, and if I 
could respond, if this is a question that I could respond to.
    Senator Sarbanes. Sure.
    Mr. Taylor. Throughout this period that you are referring 
to in Brazil, part of my job is to be in close contact with the 
economic officials in the other countries with, for example, 
Arminio Fraga.
    Secretary O'Neill is equally in close contact with the 
officials in those countries. He made a trip to the region at 
roughly the same time that you are referring to these quotes.
    He has a great deal of knowledge of Brazil and supports the 
Brazilian people, has friends there, business contacts, over 
many years. Our relationship with the Brazilian economic 
officials is good and continuous. And the same with the 
markets.
    Markets move for many reasons. And I believe that what we 
have been trying to do and what the Secretary has been trying 
to do effectively is to maintain the contacts with the people 
in the markets, with the officials in Brazil. It is a very good 
relationship and as I have tried to indicate, there has been a 
great deal of consistency with how we have approached it.
    With that, again, you can refer to quotes and I can 
continue to respond. But I think if you put this in the broader 
context of all the testimony that the Secretary has done, all 
the speeches that he has given, I have given, and others have 
given in the Administration supporting the overall policy of 
the President on emerging markets and developing countries, 
trying to improve the lives of the people around the world, 
trying to focus on water for people who do not have enough 
water, the whole ramification, the whole spectrum of policies 
is dedicated to improving--and if you look at the whole 
context, I think you are going to see a very impressive change 
in policy on the development side and the emerging market side 
that is already beginning to have effects. So put it in the 
overall context, Senator. I would ask you to do that.
    Senator Sarbanes. Are you suggesting to me that the 
Brazilian authorities welcomed these quotes from the Secretary 
that I read?
    Mr. Taylor. You will have to ask the Brazilians what they 
thought about that. I know we have had good contacts with the 
Brazilians. The Secretary has good relationships.
    Senator Sarbanes. If they did welcome them, why did they 
react the way they did, forcing you all to make a clarifying 
statement? And also, then, to come along with these other 
statements about what a wonderful partner they have been and 
the importance of the economy, and so forth, all of which I 
agree with. But why was that necessary if they did not welcome 
them?
    Mr. Taylor. Well, because it is the whole context. If there 
is a particular statement that is made and it is quoted, let us 
give it the context. I think anyone would like to say, if there 
is one sentence that is pulled out of remarks and that is 
getting attention, let us give it the whole context that it 
belongs in.
    Your assumptions about the reasons for the changes I cannot 
agree to. But I can say that the effort is to put the whole 
thing in context. And I think the whole context is good and 
effective.
    I support what the Secretary is doing.
    Senator Sarbanes. Mr. Chairman, I would just close with 
this. I want to quote Tarullo again. You will have him on the 
next panel.
    ``The voice of a U.S. economic official is itself an 
important instrument of policy. A consistent, measured, and 
coherent voice establishes credibility, reassures market 
actors, and enhances U.S. 
economic leadership. The absence of such a voice has just the 
opposite set of consequences.''
    Thank you for doing this hearing.
    Senator Bayh. Thank you, Chairman Sarbanes, for your time.
    We are very grateful to you, and for the Full Committee's 
support of our hearing.
    Thank you.
    Mr. Taylor, I have a few more questions. I know we have 
kept you a while.
    Let me return to the topic of contagion. You have suggested 
once again that the market is getting better at evaluating 
risks and so forth, and that what we have traditionally 
considered to be contagion is not as great a risk as it used to 
be. And in the case of Uruguay, I think you used the term, 
direct interconnectedness. How would you differentiate between 
direct interconnectedness and what we would traditionally 
consider to be contagion?
    Mr. Taylor. The former is where there is a trade flow or a 
financial connection. Tourism, for example. Montevideo is just 
across the river from Buenos Aires.
    Senator Bayh. So it is physical proximity?
    Mr. Taylor. That is one way to measure it. Frequently, 
there is more trade between countries that are close to each 
other. Not all the time, but it is frequently a way.
    But the other would be where there is no real connection. 
Let us take Brazil and the Philippines, for example. Or take 
Russia and Argentina. In 1998, when Russia defaulted, there was 
an impact in Argentina. But there is very little direct 
connection in terms of trade flows between the countries, say, 
compared to Argentina and Uruguay. In 1998, there was an 
impact, a visible impact on the spreads on interest rates in 
Argentina after that default in Russia.
    Senator Bayh. Are interest rate spreads the only thing you 
look at to determine whether there has been a contagion effect?
    Mr. Taylor. No, but that is the one that has been given the 
most attention in the markets. It is the one that people refer 
to mostly in the financial crisis earlier. No, there is clearly 
other things to look at.
    Senator Bayh. Let me read a couple of quotes and get your 
reaction to this. You are aware that there is another school of 
opinion on whether contagion continues to be a potential 
problem or not.
    This is a story from The Wall Street Journal on Monday of 
this week. It is entitled, ``Guilt By Association--U.S. 
Officials Insist 
Financial Contagion Is Over. Period. Not So Fast.'' That is the 
headline. And let me read you a couple of quotes and get your 
counter-argument here with regard to Argentina.
    ``But with Argentina in default on most of its government 
debt, investors also focused on whether Brazil could sustain 
payments on its own debt regardless of the outcome of the 
balloting, suggesting that there was more than just political 
risk there at play.''
    This is a quote--`` `Seeing Argentina, nobody wanted to 
take chances and give Brazil the benefit of the doubt,' says 
Walter Milano, head of Emerging Markets Research at BCP 
Securities, Inc., a brokerage firm in Greenwich, Connecticut.''
    That sounds like classic contagion to me, with everyone at 
the risk premium rising, not because of political factors, but 
just because of a generalized fear spawned in Argentina that 
Brazil might also have been in trouble.
    The second quote is, and this deals with the spread of 
political risk. `` `People are much more concerned about making 
long-term investments and they are reviewing contracts backward 
and forwards,' says David Gould, Director of Global Economic 
Analysis for the Institute of International Finance.''
    ``There is a sense among international investors . . .,'' 
he says, that once a country opens its markets, ``. . . it 
doesn't mean they are open forever.''
    You know what is going on in Argentina with the bankruptcy 
laws and the abrogation of contracts and that kind of thing.
    What do you say about these comments? It sounds as if at 
least some people are perceiving the existence of good old-
fashioned contagion out there.
    Mr. Taylor. I found that the stance that we took early in 
the Administration that contagion had changed got quite a bit 
of criticism when the Secretary made it and when I made it.
    But the things we referred to were the spreads, and that 
was the measure. And in fact, we turned out to be quite 
correct, as I have indicated with respect to comparison of 
Russia and Argentina.
    But I have also noted that people have sometimes developed 
new interpretations of contagion or perhaps referred to old 
ones. I really do not think it makes a difference.
    One of them is this political contagion idea. And the idea 
is that perhaps countries see the politics or policy changes in 
one country, or investors see those changes, and worry that 
another country is going to take those same policy stances, 
same policy changes. I do not see a lot of that, to be honest, 
because I see the message from poor policies such as----
    Senator Bayh. I am sorry, Mr. Secretary. You do not see a 
lot of what?
    Mr. Taylor. I do not see a lot of the so-called political 
contagion.
    Senator Bayh. What is going on in Brazil?
    Mr. Taylor. There was a lot of concern that the halting of 
a privatization in Peru was due to political contagion, that 
people said, we do not want that privatization because we see 
what is happening in Argentina.
    It was completely wrong. It was a local issue. The people 
in the community wanted to be involved in the privatization. 
They indicated their views. The government has changed. It had 
nothing to do with political contagion. It did not exist.
    The other thing is, this is speculation. You said that we 
should improve our political analysis. That is probably right.
    But what would be the message that a country would get from 
what Argentina has done in the last year, changing the 
bankruptcy law in a negative way. It is fortunately fixed now.
    It would be negative. These were leading to bad, have led 
to bad results. And I think the message, by looking at it, and 
maybe, comparing Chile, is that we should do what countries 
that are succeeding do, not what countries that are failing do.
    So you can speculate about what is going to cause policies 
to change, but to me, countries and investors will look around 
and follow the policies that work. That is not to say that 
investors do not get worried when they see a policy change in 
one country that looks bad that another country might adopt it. 
But I think there is just as many who might view it the other 
way.
    When I talk to people in the markets, I hear both sides. 
Actually, that is what markets are all about--differences of 
opinion. Every quote you get from one side, there has to be 
somebody on the other side of that market.
    Senator Bayh. Indeed. How do you interpret what is going on 
in Brazil, then, if they have, as we have said, sound economic 
policies, and yet, they have had great turmoil here, a lot of 
it focused on the potential outcome of this election. Isn't 
there at least an element there of looking to--there is 
uncertainty about what path a new government will adopt. Is it 
possible to say that that is not exacerbated by what has 
happened in Argentina?
    This man is saying that they are looking at contracts back 
and forth. What kind of policies a new government might be 
inspired to implement?
    Mr. Taylor. I agree with you. There is uncertainty about 
the election.
    Senator Bayh. Your position, that is all indigenous to 
Brazil. That is not affected by what has happened in Argentina?
    Mr. Taylor. I think, for the most part, it is an issue in 
Brazil. It is an issue of what the new administration will do.
    They will make their decisions like anybody else, on the 
basis of many factors. They may look to Argentina, but what 
they find might be a policy to follow which is more conducive 
to economic growth, by doing the exact opposite of what is done 
there.
    But the uncertainty about what a new administration will do 
is there and I think that is the reason the policies on the 
inflation side, on the fiscal side, on the social side, have 
been good in Brazil. I think the markets would like to see good 
kind of policies continue. There is uncertainty about that, as 
you know, Senator.
    Senator Bayh. Just to digress to the broader point that I 
was making initially that you returned to.
    It is in some respects a dilemma. You cannot reward bad 
political decisions because you will just get more of them.
    On the other hand, I think when we evaluate policy 
prescriptions, there is an element of realism in terms of what 
the society in question will tolerate. There is a threshold of 
pain beyond which you go, you are going to be self-defeating as 
well. Now how to strike that realistic medium, that balance, is 
the challenge, and it is not an easy one. But to ignore the 
need for a balance, I just think is going to be self-defeating, 
too.
    Mr. Taylor. Yes. That is why I think that we have to be 
gradual as we implement these new ideas.
    Senator Bayh. I think we have talked about contagion in the 
context of Uruguay, in the context of Brazil.
    I was curious about one thing. We talk about interest rate 
spreads and absence of political contagion. I believe earlier 
this year, it may have been in August, Brazil's credit rating 
was downgraded to the point where only Argentina and Nigeria 
have a lower credit rating now. What is the market reflecting 
there? What are the credit-rating agencies reflecting there?
    Mr. Taylor. I would say the same thing the markets are, 
this uncertainty about what will happen.
    Senator Bayh. In your opinion, it is mostly indigenous to 
Brazil. It is not a heightened risk premium.
    Mr. Taylor. Chile is right next door to Argentina. They 
remain with investment-grade rating. Mexico is investment-grade 
rating and their policies are good.
    I think you have to look at those cases, too.
    Senator Bayh. Let me shift gears for just a moment and ask 
you about the IMF and our relationship to the Fund. I am told 
the top five borrowers now have 80 percent of the Fund's 
exposure, which is the highest concentration in history. Is 
that a prudent level of risk to run?
    Mr. Taylor. That is a measurement of the existing loans 
that are out there. There is a lot of liquidity that the IMF 
still has.
    Senator Bayh. It seems like a pretty high concentration.
    Mr. Taylor. What you say is completely true. There are a 
lot of other Fund programs, but they are very small. The large 
fraction is in these countries. It does not represent a risk 
element of the kind that the figures indicate because the IMF 
has not lent out all the funds that it has. There is a lot of 
liquidity that is there, if you like.
    Of the loan portfolio, it is out there and disbursed. It is 
concentrated. But I think you need to view that as part of a 
broader portfolio, funds which have not been disbursed.
    Senator Bayh. How much of their available funds has been 
disbursed? I do not have that figure.
    Mr. Taylor. The figure is approximately 30 percent. I 
believe 25 or 30 percent. I will have to get back to you on 
that, Senator.
    I know they have about $90 billion that is in liquidity at 
this point in time that can be used for further programs.
    Senator Bayh. Let me ask you another question with regard 
to our relationship with the IMF. And I know that you get 
criticized either way. If you are too aggressive, you get 
criticized. If you are too passive, you get criticized.
    There is an impression on the part of some that this 
Administration has been a bit more passive in attempting to 
suggest what the appropriate policy might be to the Fund.
    As the largest shareholder, what should our relationship to 
the Fund be? Don't we have some obligation to determine what we 
think is sound policy and urge them to adopt that? If so, have 
we been doing that?
    Mr. Taylor. Most certainly, we have a responsibility and we 
have been doing that. We are in close contact with Fund 
management. The Secretary has regular meeting with the managing 
director of the Fund. I have close contacts with the 
management. The staff interacts an awful lot. And, yes, we are 
very engaged with the Fund.
    I do not think there is any substitute for that, Senator. I 
wish there were, but it really is the kind of thing where you 
have to occasionally get into the details and look carefully at 
a program and go over there and talk and get the numbers out. I 
do that myself. I think it is very important to do it. I would 
not describe the relationship as passive.
    We would like to have the Fund accountable for its 
decisions and responsible for its decisions. But that does not 
mean that we cannot be engaged.
    And if I could just say one more thing on this. In the 
broader group of international financial institutions, we are 
trying to have our executive directors get engaged more with 
the development of programs and loans and not wait until they 
come to the board and have to vote yes or no, but actually get 
involved in the creation.
    When I was just recently in the Philippines at the Asian 
Development Bank, I spoke to the President about having our 
Ambassador there get engaged at a very early stage in the 
development of loans and grants. They have agreed to do that.
    That is just an example of how I think in order to affect 
the institutions in a positive way, you just cannot wait until 
the things come to the board and say up or down.
    So, we are doing that, big time.
    Senator Bayh. Certainly, in my opinion, we are not 
hesitating to express our preferred policy to the United 
Nations these days. I cannot see why the Fund would be much 
different.
    I agree with your statement. You would take exception to 
the characterization that we have been more passive with regard 
to the Fund.
    Mr. Taylor. Yes, sir, I certainly would. Yes.
    Senator Bayh. One last question with regard to our 
relationship to the Fund. And then I am going to get to the 
other panel. But at least we will spend some time on the 
alternative debt restructuring mechanisms because that was part 
of the agenda here today. About fixed exchanged rates. What 
should the policy be with regard to that? What would you 
recommend regarding currency boards like Argentina's? And if 
they appear to be unsustainable, do not just postpone the day 
of reckoning with greater consequences at the end of the day?
    And forgive me. You had something in your statement that 
alluded to what your answer might be. But I thought we would 
flesh it out a little bit. You say most countries now maintain 
``. . . floating exchange rates, helping them to adjust more 
easily when faced with economic shocks.''
    Mr. Taylor. Yes. I believe that flexible exchange rates are 
better than these pegs that had existed and were more common in 
the past. And we are moving to a very healthy, greater degree 
of focus on keeping inflation low, and that frequently means 
that the exchange rate is going to be more flexible.
    However, I do think that there are good cases where you can 
have a very credible connection to another currency. And one 
example of that is El Salvador, which had dollarized very 
successfully.
    And that is kind of the other extreme, Senator, where you 
have locked into another currency and you can benefit from 
that. That creates its own type of stability.
    The problems are in between the flexible and this super-
strong connection. And I think that is the good thing about 
what is happening, and maybe the reason why there have been 
fewer crises so far, and I hope that continues in terms of the 
number of countries, is that there is more floating and more 
focus on keeping inflation down.
    Senator Bayh. And as you know, there is this--I will call 
it a theological position out there that fixed-exchange rates 
are good in almost all cases. We have learned from hard 
experience I think that sometimes that is not true.
    Mr. Taylor. Yes. This is an area where I think theology 
does not really help you very much.
    Senator Bayh. It is not the only area where you get into 
religious debates these days.
    [Laughter.]
    But certainly one of them. Just two final questions and 
then let us turn to the debt restructuring alternatives.
    I would like to ask you about one other dilemma that 
occasionally comes up, Mr. Secretary. You said in your 
testimony that not every crisis results from a fiscal deficit, 
for instance. And so, not every program should automatically 
require fiscal retrenchment, an eminently sensible statement.
    What do we do in cases, and there are some, where there is 
no doubt that a lack of fiscal discipline is a part of the 
long-term problem, part of the underlying difficulty that is 
affecting an economy, but in the short run, demanding fiscal 
rectitude may exacerbate the economic downturn that we are 
attempting to pull the country out of. What do you do about a 
situation like that? There are a couple of them out there.
    Mr. Taylor. Well, when you make reforms, which is really 
what you are talking about, reforming of fiscal policy toward a 
sounder approach, there is always a question about how rapidly 
to do it. And I think that that is really the way to answer 
your question.
    If in the particular circumstance a country can get out of 
these fiscal problems, but it needs to do it over several years 
rather than overnight, and it can continue for several years, 
then that would be a way to alleviate a lot of the pain.
    I, at one time, did calculations that if a country could 
very credibly commit to a gradual reduction in the fiscal 
deficit, that it would begin to have its own positive effects 
right away because it would see that there is going to be less 
borrowing in the future. That could bring interest rates down.
    If it could credibly do that, it could alleviate a lot of 
the pain. And I would certainly encourage countries that can 
achieve that credibility to do so. But we are still in a 
situation where there is really not enough fiscal 
responsibility in many countries, and I just want to talk about 
globally at this point.
    We still have a problem with debts. Interest rates the 
countries have to pay are still too high, and that is because 
of these problems on fiscal responsibility, primarily.
    I would certainly like to talk more about how important it 
would be to have sound fiscal policies.
    Senator Bayh. Well, a lot of it gets back to political 
credibility. The last time you were here, we were focusing on 
Argentina, and there has been a real problem there with 
pronouncements that sound good, but they are never implemented.
    And so, I think that the posture that we have adopted at 
the time the provision of assistance with the actual 
implementation of reforms is a very judicious course of action.
    But you do hear these criticisms out there of the Fund that 
occasionally prescribes fiscal discipline at a time of economic 
contraction which, the argument goes, only exacerbates the 
problem.
    Mr. Taylor. I hear that criticism and it is an example of 
one reason why we want to be in close contact and would want to 
look at the programs carefully to make sure that it doesn't 
happen.
    Senator Bayh. At the same time, they have to make better 
long-term fiscal decisions to ever really have a sustainable 
recovery.
    So it is a balance, and I am glad to hear your answer on 
that.
    One last aside, and then let us get down to the issue of 
CAC's and SDRM's, just briefly. And to the other panelists, I 
thank you for your forbearance here.
    The President of Colombia was in town a couple of weeks 
ago. I was very impressed with President Uribe. We have clear 
U.S. interests implicated there and a host of challenges, in 
addition to economic ones.
    This gets me into another area. When, if ever, is it 
legitimate to consider geo-political factors in addition to 
economic ones? As you are aware, some people have suggested 
that played a role in the case of Turkey, possibly Pakistan. We 
now have Colombia, which has in the past attempted to pursue 
sound economic policies.
    When President Uribe outlined his prescriptions for dealing 
with the host of challenges, they seemed eminently sensible to 
me, but politically very difficult.
    I cannot claim to be a student of the Colombian political 
scene, but if we were attempting to do some of these things in 
this country, I can know how difficult it would be.
    When is it appropriate to consider noneconomic factors in 
the provision of assistance? And was that an element in the 
case of Turkey and Pakistan?
    Mr. Taylor. Well, speaking generally, there is, of course, 
a big role for assistance to countries for reasons that are 
political or are security-related. There is no quarrel with 
that at all. But what we need to try to do is to make sure that 
that assistance is not counter-productive with respect to the 
economic side of the policy.
    That is, I think, something that we are emphasizing a lot. 
You mentioned Colombia. In Colombia, the President is taking on 
a real challenge and we want to be of assistance. We hope we 
can help his country economically, too. But we want to make 
sure that our support for the economy is because the economic 
policies are good and that that can help the economy and focus, 
if you like, the security assistance on these other areas. So 
it is difficult to separate, but I believe we can and we should 
keep trying to do it.
    The same thing is true in Turkey. The assistance for Turkey 
in the past has been certainly related to security issues. But 
what we need to do is have our economic assistance based on how 
we can support them economically.
    One last example of this is this Millennium Challenge 
Account that the President has proposed. That economic 
assistance is supposed to be based on policy. That part, that 
new money, is supposed to be on economic policy grounds, 
economic growth, not on the other issues that you mentioned. 
And I believe it will be if we adhere to the principles that 
the President wants to follow and that you want to follow. But 
that does not mean that our other assistance is not sometimes 
going to go for issues related to security. But there is a way 
to separate the two.
    Senator Bayh. Do you consult with the State Department, or 
the Defense Department, with regard to those aspects of 
assistance?
    Mr. Taylor. We have a lot of good discussions and a lot of 
coordination with Defense and State and Treasury in the 
Administration, yes, on exactly these issues. Yes.
    Senator Bayh. Thank you.
    Mr. Secretary, let me just ask one or two quick questions 
because we are going to have a vote coming up at noon and I 
want to give the other panel a fair amount of time. I do not 
have to leave at noon, but I have to leave shortly thereafter.
    You have been associated with the collective action clause 
initiative. The Fund leadership has been associated more with 
the sovereign debt restructuring mechanism. Can you just 
briefly discuss the comparative advantages or disadvantages of 
the two approaches, and tell me, are they mutually exclusive, 
or might there not be some way to move along parallel tracks 
here?
    I know some have suggested that because it would take 
Congressional action, the sovereign debt approach might take a 
little longer, so you try and encourage the CAC's in the 
shorter run. What are the comparative advantages and 
disadvantages in your mind of the two?
    Mr. Taylor. One important advantage of the collection 
action clause is we can move those very quickly. We are 
encouraging the issuers in the private sector to do that.
    Last April, we outlined some basic parameters that we think 
these clauses should have. The majority action, so that there 
can be a change in the terms, some representation of the 
creditors, some way to deal with legal actions in a way that is 
constructive. And the private sector is actually working quite 
well to pursue that, I think. It has been a much more positive 
response to that approach than we have heard in the past. As I 
said, these kinds of things were first suggested in 1996.
    So that is the advantage. I think the purpose, just to be 
very sure, is to make the process more predictable, to make the 
markets work better. We do not want to encourage default in any 
way. We do not want to increase the cost of it, do not want to 
increase the likelihood. It is to make the restructurings more 
orderly when they occur. The sovereign debt restructuring 
mechanism requires statutory changes. As you say, that means it 
will take a longer period of time.
    Senator Bayh. Are you suggesting that the Congress cannot 
act quickly, Mr. Secretary?
    [Laughter.]
    Mr. Taylor. There are a lot of legislative bodies in the 
world that are required here.
    Senator Bayh. Mexico made a statement not long ago that 
they were not inclined to incorporate CAC's. Is that because 
they fear higher interest rates will be required? And if so, 
what do you do about that if the issuers--they do not perceive 
it as being in their interest to include them, and therefore, 
do not?
    Mr. Taylor. Well, some issuers have already indicated a 
strong interest in pursuing it. For example, Russia, South 
Korea, have been positive about it. But the concerns that 
countries raise, and you mentioned the example of Mexico, is 
exactly that, that the costs of borrowing will be higher.
    The evidence, however, suggests that that need not be the 
case. For example, there are collective action clauses in the 
United Kingdom markets. They exist. The studies that have been 
done do not see that they are more expensive. In fact, for good 
performers like Mexico, such clauses reduce the price of 
borrowing.
    I think there needs to be more discussion on this. In the 
mean-
time, some countries are interested in pursuing it in the New 
York market. The New York market is where these do not exist. 
They do exist in London. We want them to move ahead in the New 
York market, and I can see some interest in it at some point.
    Many emerging markets have indicated strong reservations 
about the sovereign debt restructuring mechanism approach. But 
with respect to collective action clauses, there is much more 
enthusiasm at this point in time, and we should welcome it.
    Senator Bayh. On the part of the lenders?
    Mr. Taylor. On the part of the lenders, certainly. We 
should welcome that, which we are.
    At the same time, I think from a public policy point of 
view, we want to consider what an alternative would be, what 
the sovereign debt restructuring mechanism would look like. We 
haven't seen a complete proposal about it yet. And that is one 
of the reasons why we are still discussing it.
    Senator Bayh. Last question, and then one closing comment.
    Is this made more difficult by the fact that a lot of the 
borrowing today is in the form of bond issues, as opposed to 
bank loans? Doesn't that complicate the issue here a bit?
    Mr. Taylor. It is more complicated because there is more 
diffuse holdings of the securities. And people all over the 
world, small investors--that makes it more difficult. That is 
why these clauses will make a big difference, because it is a 
way for voting to take place if there needs to be a change in 
the terms.
    Senator Bayh. There is enough institutional holding, 
though, that you could still get a super-majority sufficient to 
move forward under these clauses?
    Mr. Taylor. Yes, we believe there is.
    Senator Bayh. Okay. My last comment. First of all, thank 
you for your time, Mr. Secretary.
    Mr. Taylor. Sure.
    Senator Bayh. You have been very generous. I would simply 
say, and I think you have outlined that this is your desire as 
well, let us pick a policy and stick with it. Make it as 
transparent as we can, with as much objective criteria as we 
can. I think that lowers the uncertainty and reduces both the 
risk of contagion and moral hazard. That really was the purpose 
behind the hearing today. So, I urge you in that effort and 
look forward to continuing our work together.
    Mr. Taylor. Thank you very much, Mr. Chairman. I appreciate 
your last remark particularly.
    Senator Bayh. Thank you.
    [Pause.]
    Thank you very much, gentlemen, for your patience. The 
first panel took a little bit longer. We had a lot of ground to 
cover.
    Why don't we just move from your vantage point from the 
right to the left, starting with you, Mr. Tarullo, then to Dr. 
Mussa, and finally, Mr. Otteman.
    By the way, Dr. Mussa, I indicated before you arrived, I 
got a good chuckle about reading about your cat last night.

    [Laughter.]

    I thought there were definitely some analogies to be drawn 
there. It is not often that I get a chuckle out of testimony 
before the panel, but it was welcome. Thank you.

    Mr. Tarullo, let us begin with you. I think, as he 
suggested, the Chairman did a good job of drawing upon some of 
your comments in his questioning. And so, given the hour, 
please go ahead.

                 STATEMENT OF DANIEL K. TARULLO

                        PROFESSOR OF LAW

                GEORGETOWN UNIVERSITY LAW CENTER

    Mr. Tarullo. Thank you, Mr. Chairman. Let me say just a 
couple of things, because Senator Sarbanes did point to one 
issue I wanted to raise.

    The another point I wanted to make, which I will state 
briefly here, is what is really at stake in the issues 
implicated in this hearing.

    I think it is really nothing less than the medium-term 
direction of economic policy in South American countries. It 
was, not quite 8 years ago that the leaders of all but one of 
the countries in this hemisphere met in Miami for the Summit of 
the Americas, hosted by President Clinton. At that time, the 
sense of optimism and sense of engagement were really quite 
extraordinary. And here we are, fewer than 8 years later, 
feeling quite nervous about both the political and the economic 
direction of Latin America.

    Now, we can sit here and worry about it. The question is 
what can we do about it? And that is where your hearing plays 
an important role, because you are focusing attention on the 
existence and implementation of coherent policies.
    In my judgment, both the Administration and the Fund need 
to be rather more proactive than they have been. So, it seems 
to me, that in addition to the problem of coherence which you 
and Senator Sarbanes pointed out before the earlier panel, that 
we do have a problem of a certain absence of proaction.
    I believe that the Administration needs to help Argentina 
find a way out of its economic calamity and do so in a way that 
indicates a continuing effort by the Administration to come up 
with a menu of policies that might help the country move 
forward. I think simply waiting by the phone, although an 
admirable effort at restraint and nonimposition of policies, 
leaves a confused government in a confused state.
    I also think we need to help Brazil find a way into 
successful regional integration. And that two counsels 
continued engagement and continued efforts on the trade side, 
as well as on the financial side. But there again, I think our 
presence needs to be not just privately indicated, I think it 
needs to be publicly apparent as well.
    In the case of the Fund, Senator, there is a certain irony 
here. For years, many people, myself included, have been 
critical of the Fund for an excessive focus on fiscal policies 
or on exchange rate policies or an excessive imposition of 
conditions for IMF resource programs.
    The histories of Argentina and Brazil--as my fellow 
panelist, Mike Mussa's work has quite successfully shown--may 
indicate an insufficient attention on the part of the Fund to 
some unsustain-
able policies that go against the grain of the Fund's own 
predisposition: The long-term run-up of debt and the fixed 
exchange rate policies, were problematic.
    But that observation does raise the very delicate questions 
of sovereignty and how much intervention we do want the Fund or 
the U.S. Government to make in these circumstances. And that is 
one issue where I do not think there are any clear answers and 
I do think a continuing dialogue in fora such as this are quite 
important.
    Finally, Senator, as you know, and Senator Sarbanes has 
said on many occasions, Congress cannot make policy on a day-
to-day basis. That is why you have an oversight function.
    But it does seem to me that this is a little bit like 
chairing an interagency meeting.
    I always found that Treasury, State, and the other agencies 
were somewhat resistant to programs coming from White House 
staff as to what they should do. However, if you called a 
meeting, asked a question, and threw a piece of paper on the 
table, the chances were that by the next meeting, the agency 
would have its own program addressing the same kind of problem 
that you wanted them to address. And I think a hearing like 
this does very much the same thing and thus I applaud and 
appreciate your conducting it.
    Thank you.
    Senator Bayh. Thank you very much, Mr. Tarullo.
    Dr. Mussa.

               STATEMENT OF MICHAEL MUSSA, Ph.D.

                         SENIOR FELLOW

            INSTITUTION FOR INTERNATIONAL ECONOMICS

    Dr. Mussa. Thank you, Mr. Chairman.
    Senator Bayh. Elmer.
    Dr. Mussa. Elmer the cat, yes. Actually, he had a longer 
name--Elmer Aloysius Alcibiades Yenom, but we won't get into 
that.
    Senator Bayh. Family name?
    Dr. Mussa. No. Yenom is money spelled backward, so it is 
not entirely irrelevant to the Banking Committee.
    [Laughter.]
    I have a long written statement and an oral statement that 
you have already quoted from and that Chairman Sarbanes has 
already quoted from.
    Let me discuss three main points.
    The first point, quite briefly, the obvious inconsistency 
between the Administration's rhetoric on large financial 
support packages and the fact that they have supported an awful 
lot of them.
    To clarify one key fact, we really have had bigger packages 
more frequently than in the past. Take the case of Brazil. 
There was a $15 billion precautionary package now most of which 
has been drawn. To that has been added from the IMF another 
$30-plus billion. So the total is $45 billion from the Fund 
alone.
    Forty-five billion dollars was the largest previous package 
also for Brazil, consisting of $20 billion--this was in 1999--
from the Fund, about $10 billion from the World Bank and IDB, 
and another $20 billion from bilaterals.
    Now, we have $45 billion just from the Fund, plus another 
$8 or $10 billion, I do not know how much additional money from 
the IDB and the World Bank. So there is no doubt that the 
present official support package for Brazil is the biggest in 
history. And it may well get bigger.
    Second point in this area, in addition I believe to the 
problems that you have already discussed about the 
inconsistency of policy, I think there is a substantial problem 
that this inconsistency has contributed to poor management of 
actual financial crisis.
    And here I disagree very much with Secretary Taylor. The 
decision made in August 2001, to augment international 
financial support for Argentina was the worst single decision 
made in the 10 years that I was at the IMF. By that point, it 
was clear that they were headed down the drain and they needed 
to do a restructuring.
    Common sense suggested officials who were ideologically 
opposed to large assistance packages are poorly qualified to 
make decisions concerning their design and implementation.
    Senator Bayh. Clerics make poor economists? Is that the 
case?
    Dr. Mussa. Well, I think it is rather like asking a 
conscientious objector to serve as the commandant of the Marine 
Corps.
    Now, turning to the situation in Uruguay and Brazil, which 
was also on your list of questions. There is no doubt that 
Uruguay was going to suffer substantial either contagion or 
direct effect, whatever you want to call it, from Argentina. 
Nevertheless, little was done to help Uruguay until this 
spring, when large bank withdrawals and capital outflows caused 
the collapse of Uruguay's crawling exchange rate peg regime.
    Then IMF support was rapidly augmented to roughly five 
times the normal limit. But this was not enough, and in August, 
further official support, not just from the Fund, up to a total 
$4 billion was committed.
    For the time being at least, this solution of throwing more 
money at the problem has contained the crisis. But it is still 
unclear whether Uruguay can get through its present 
difficulties without a comprehensive debt restructuring. And 
this is an issue that has just not been consistently faced yet.
    For Brazil, so far, the international community has adopted 
a more sensible approach to a difficult situation. We had a 
precau-
tionary package more than a year ago and this summer, when more 
pressures came, as Secretary Taylor indicated, another $30 
billion was added, in the very useful form of a little bit of 
additional money now and a substantial commitment provided the 
new government was prepared to continue with sound policies.
    That was the right decision because delay until after the 
elections has been essential to get a government elected that 
will have to take the key decisions for Brazil going forward.
    In my view, however, the present policy path featuring 
Brazil's continued commitment to moderately strong policies 
backed by substantial official support is a prescription for 
disaster.
    As reflected both in interest rate spreads on Brazilian 
bonds and the exchange rate on Brazil's currency, financial 
markets see this approach as woefully inadequate, and the 
market will make this assessment a self-fulfilling prophecy.
    There are two viable approaches, one based on prompt 
recognition that comprehensive restructuring of Brazil's 
internal and external debt is unavoidable and needs to be 
managed with as little economic and financial disruption as 
possible.
    The other is based on substantially strengthened economic 
policies, including a primary budget surplus of at least 5 
percent of GDP backed by measures to constructively involve 
Brazil's private creditors and supported by a meaningful 
increase in committed international assistance.
    If another catastrophe like Argentina is to be avoided, 
tough decisions soon need to be made, with the clear 
recognition that the middle ground is untenable.
    Finally, much attention has recently been focused on the 
issue of the SDRM. I am highly skeptical about this proposal 
for two key reasons.
    First and foremost, if a workable SDRM had existed, it 
would have done little material good in helping to avoid or 
resolve the major emerging market financial crises of the past 
decade. I count 10 of them. Only in the present crisis in 
Argentina has default by a sovereign on its foreign law debt 
been a major issue. In the other nine, the SDRM would not have 
been relevant at all. And for Argentina, while there is a large 
default and a few suits have been filed, legal actions have not 
been a factor at all in Argentina's economic collapse. GDP 
dropping 25 percent, it is not because of legal actions.
    Second, and this is where Elmer comes in, while it is 
arguable that an SDRM can be moderately helpful in some 
situations and is worthy of further study, there is good reason 
for caution in moving forward.
    Those most concerned with emerging market debt, its 
issuers, its investors, and its dealers, generally oppose an 
SDRM, and some very strenuously. Their analysis may be wrong, 
or their motives may not be entirely pure, but their concern 
should not be lightly dismissed.
    Moreover, in considering the SDRM, I do point to the Elmer 
principle. Elmer was a docile and affectionate feline, except 
for the ferocity he displayed in confronting other male cats. 
In dealing with this problem, my father, who was a wise man, 
advised, it is usually a mistake to try to referee a cat fight. 
You are likely to get scratched and bitten, and your 
intervention is generally not appreciated by the principal 
participants.
    Disputes in a sovereign default are much like a huge cat 
fight, with many hissing and howling combatants and their 
lawyers. The international community, whose own motives may be 
questioned and whose authority is limited, should think 
carefully before volunteering to referee such affairs.
    Senator Bayh. Thank you, Dr. Mussa. He will be forever 
memorialized in the annals of the Congressional Record.
    [Laughter.]
    Mr. Otteman.

                 STATEMENT OF SCOTT A. OTTEMAN

             DIRECTOR OF INTERNATIONAL TRADE POLICY

             NATIONAL ASSOCIATION OF MANUFACTURERS

    Mr. Otteman. Chairman Bayh, I am pleased to be here pinch-
hitting, as you said, for Frank Vargo, my boss at the NAM, to 
talk a little bit about the effect on U.S. business from the 
crises in Latin America over the last couple of years.
    I particularly want to talk about how this affects not only 
U.S. business, but also U.S. jobs and the U.S. economy.
    The subject of today's hearing, Argentina's economic and 
political crisis and the spillover effects to its neighbors, 
has immediately affected U.S. companies in two clear ways.
    First, it has provoked a dramatic decline in U.S. exports 
to South America. Second, it has substantially harmed the 
conditions for doing business faced by U.S. firms that are 
invested and operating in the region.
    United States exports to Central and South America so far 
this year have fallen 16 percent from the same period a year 
ago. The three largest proportional declines were to Argentina, 
Uruguay, and Brazil.
    United States exports to Argentina have plummeted a 
stunning 67 percent, dropping from an annual rate of $4.5 
billion to $1.5 billion, a $3 billion fall. Exports to 
Argentina face a triple whammy. First, there is low demand due 
to 4 years of recession and depression in that country. Second, 
they face a huge competitive disadvantage due to the 70 percent 
devaluation of the Argentine peso, which, as you know, makes 
foreign imports much more expensive than similar domestic 
goods. And third, there are import curbs imposed by Argentine 
authorities to improve the country's current account balance.
    United States exports to Uruguay, meanwhile, have fallen 53 
percent and exports to Brazil have dropped 26 percent, from an 
annual rate last year of $16.5 billion to $12.2 billion so far 
this year.
    The Commerce Department estimates that each $1 billion of 
exports supports approximately 12,500 U.S. jobs. This implies 
that the export losses over the last year to Argentina, Brazil, 
and Uruguay may have impacted over 90,000 American jobs.
    With respect to United States investment in South America, 
the income earned on those investments has dropped 
precipitously. For instance, United States foreign direct 
investments in Argentina, the worst case, have lost $2 billion 
in the last 9 months alone.
    Given the depths of Argentina's crisis, it makes sense that 
those U.S. businesses with operations in Argentina are the ones 
that have been most severely hurt. I refer you to my written 
testimony for a fuller description of some of the crisis-
related measures taken by Argentina's authorities, which 
continue to impair companies' abilities to function without 
suffering substantial losses.
    Perhaps the longer-term danger the current situation poses 
for United States business and for the common interests of 
Latin America and the United States is the emerging perception 
among the people and politicians of the region that financial 
crises and economic stagnation are somehow caused by free-
market reforms.
    Here, I think I am a little less sanguine than the Under 
Secretary was in the sense of there being potential copy-cat 
effects of politicians looking at the inability of the reforms 
so far to produce the desired results.
    Senator Bayh. The danger of political contagion that he and 
I were talking about?
    Mr. Otteman. Yes. In our view, however, any attempt to turn 
back the clock by returning to an import substitution model or 
other policies of the past will be a costly mistake. Although, 
in hindsight, some of the reforms of the late 1980's and 1990's 
perhaps could have been carried out more gracefully, maybe at a 
different pace or in a different sequence, the main problem 
continues to be not that reform has gone too far in Latin 
America, but rather, that the reform process in many cases has 
not yet gone far enough.
    A few words about Brazil in light of its size and the 
extent of United States private activity there.
    If financial collapse were to spread to Brazil, the 
potential negative impact on U.S. business would be vastly 
enlarged. Some 400 of the United States Fortune 500 companies 
have operations in Brazil. A Brazilian financial disaster such 
as Argentina's would not only undercut the operations of United 
States firms invested in and trading with Brazil, but also 
could spread investor panic and depress growth prospects 
throughout Latin America and perhaps the rest of the developing 
world, similar to what we initially saw with Mexico in 1994 and 
with Asia in 1997. In my opinion, though, this unwelcome 
scenario is far from inevitable and certainly can and must be 
avoided, if at all possible.
    U.S. policymakers and the international financial community 
have important roles to play in avoiding this type of disaster. 
I will leave it to my co-panelists, who have hands-on 
experience in these matters, to make recommendations to the 
U.S. Government and IMF. However, the experience of our members 
who are international traders and investors leads us to believe 
that the most critical role in avoiding such a crisis will 
inevitably fall to Brazil itself. Regardless of who wins the 
October 27 presidential run-off, the new Brazilian President 
can do much to allay the concerns found in financial and 
business circles today.
    For example, he might appoint an experienced economic team 
that understands international finance and recognizes the 
importance to Brazil's future of deeper and broader integration 
into the world economy. He could also make it manifestly clear 
that his government will honor its international debt and other 
obligations. He could reaffirm Brazil's commitment to 
successfully negotiate a Free Trade Area of the Americas by the 
agreed deadline of 2005.
    Once the immediate threat of financial crisis is averted in 
Brazil, Argentina, or elsewhere, there are additional steps 
that must be taken to achieve a stable democratic and 
prosperous Western Hemisphere. I will just mention one. That 
is, this idea of the Free Trade Area of the Americas being 
reinvigorated now that the United States has Trade Promotion 
Authority.
    Senator Bayh. Thank you, Mr. Otteman. Forgive me for 
interrupting. That buzzer you just heard, I think, was them 
calling a vote, which means I have about 10 or 12 minutes 
before I dash over there.
    Would you mind if we submitted the rest of your statement 
for the record and I went to some questions for the panelists, 
yourself included?
    Mr. Otteman. Certainly, Mr. Chairman.
    Senator Bayh. Thank you very much. I appreciate your 
willingness to do that.
    Senator Bayh. Mr. Tarullo, moving quickly, you heard the 
Under Secretary say that, in his opinion, the phenomenon of 
contagion was really not what it used to be for a variety of 
reasons.
    I think I know what your reaction to that will be. Can you 
give us your opinion?
    Mr. Tarullo. Senator, in my judgment, the nature of 
contagion depends on the nature of the financial crisis. It is 
obviously the case that we do not have the situation of the 
mid- to late-1990's when there was a lot of short-term 
portfolio investment around the world which could flow out very 
quickly. That was the kind of contagion that we experienced in 
the 1997-1998 period.
    Although it is important to be analytically careful to 
distinguish different reasons for different kinds of contagion, 
it is equally important to address the effects that actually 
are entailed. And that is where I fear that there is a certain 
acquiescence by the Administration in things that they call 
interconnectedness, or political contagion. These are all 
phenomena that have the effect of spreading economic problems 
and thus they all require a response.
    Senator Bayh. Without getting into semantic arguments, the 
point here is that they are contagion, nonetheless. Different 
forms, different types, but they are destabilizing to the local 
economies. They spread to other nations and eventually affect 
our interests. Is that correct?
    Mr. Tarullo. That is correct, Senator. And to the degree 
that the contagion is so-called real economy contagion, or what 
the Secretary called interconnectedness, that is a lot easier 
to predict. It did not take a lot of analysis to know that 
Uruguay was going to have problems when Argentina went into a 
financial crisis because all the Argentine citizens have their 
money in Uruguayan banks.
    Senator Bayh. But we waited, and then had to come up with a 
much larger package in the event. Correct?
    Mr. Tarullo. Correct.
    Senator Bayh. Postponing the day of reckoning only 
sometimes makes it more difficult.
    Mr. Otteman, for your members, this is not a theoretical 
issue. It is a real issue. And as I understand your testimony, 
you see a risk for premiums for doing business in other 
countries being affected by all of this. Correct? Politically 
and otherwise? Argentina is having an impact on American 
businesses attempting to do business in other Latin American 
countries. Is that correct?
    Mr. Otteman. I do agree with the Under Secretary that the 
main effect has been the trade effect with the neighboring 
countries and that you have not seen the spread. But with 
Brazil, there could be a much greater potential for that in 
terms of the size of the economy and the size of the United 
States company involvement there.
    Senator Bayh. Mr. Tarullo, back to you, and then possibly 
to Dr. Mussa.
    The Under Secretary was admirable in his attempts to defend 
the consistency of the policy over the last couple of years as 
it related to some of the statements that had been made.
    But it does seem to me, and I think to Chairman Sarbanes, 
that there has been a certain amount of cognitive dissonance, 
shall we say, within the Administration which has led to some 
inconsistencies and therefore, higher costs and greater 
problems.
    Hence, my request that he pick a policy, let's stick with 
it. We are going to have fewer problems if we do that. Is that 
your impression as well? There has been some cognitive 
dissonance here? And if so, what do you think accounts for 
that? Is it ideology running into real-world problems?
    Mr. Tarullo. Senator, I do agree with you. Let me start 
with a somewhat more sympathetic note for the Administration.
    These are not easy problems. There are no simple solutions 
out there. And one thing I think we can applaud the 
Administration for doing is resisting in practice simplistic 
solutions that have been urged upon it.
    Senator Bayh. That would be the more absolutist ideological 
approach. Correct?
    Mr. Tarullo. Correct. And indeed, the risk is that one 
adopts a rhetorical position that seems highly principled, some 
might call ideological, and then rather regularly departs from 
those principles in practice.
    It seems to me that that gives you the worst of both worlds 
because the markets and other governments are not able to plan 
based upon your stated policy, and then they cannot see the 
relationship between what you actually do and what you say.
    Senator Bayh. Uncertainty has real-world costs.
    Mr. Tarullo. Correct. And Senator, that is not to say that 
there needs to be absolute consistency and a kind of hard-line 
that people just stay with. Evolution and flexibility, sure. 
But the markets and, other governments need to see a strain of 
consistency in a policy.
    Senator Bayh. Rhetorical consistency would be beneficial as 
well. I think as Chairman Sarbanes was exploring in some 
detail, there have been a couple of cases where statements have 
been made that were not helpful. Let us just put it that way.
    Dr. Mussa, why the inconsistency in your opinion?
    Dr. Mussa. Well, I think, as you suggest, I would divide it 
into two problems.
    One, I think there have been some unfortunate statements 
that have been made in less than formal context, which I think 
should have been regretted at the time. And two, I think the 
other problem has been substantive, that the policy really has 
not been clear. There has been clear rhetoric opposing large 
packages and there have been a lot of large packages.
    [Laughter.]
    That is the reality that you need to do something about 
these crises, even if it was not what you were thinking before 
you were in office. But this is not just a perception that I 
have.
    Senator Bayh. Forgive me for interrupting. Has the 
ideological reluctance to intervene, when forced to be 
confronted with reality and forced to change, has that 
contributed to the increased size of these packages?
    Dr. Mussa. Well, I think that is a very difficult judgment 
to make. There are 6 or 7 instances.
    I do think geo-political considerations have clearly played 
a very important role in Turkey, and particularly after 
September 11. Whether Secretary O'Neill's comments and the 
reactions to them induced a larger Brazilian package or not, I 
do not know. I think that that package, backloaded, was the 
right thing to do in the circumstances, whether or not there 
had been any such unfortunate remarks.
    I would note that this problem is not just in our 
perception. I quote Peter Costello, the Treasurer of Australia, 
from his official 
release statement to the IMFC.

    What counts is what the Fund actually does rather than what 
it says it will do. Ultimately, as the quality of the judgments 
that are taken in each case and whether the frameworks are 
applied consistently which will determine whether the Fund is 
successful in helping to resolve crises.
    In effect, each decision will be part of an ongoing process 
of defining the role and success of the Fund. It is important 
that its actions are consistent with the stated intentions.

    This has not always been the case.
    Senator Bayh. The market players look at the actions, not 
just the rhetoric. But consistency of both would be helpful and 
it has been problematic in both cases. Is that a fair summary?
    Dr. Mussa. I think so. And also, in the 20 meetings of the 
IMFC and its predecessor committee that I attended, long and 
boring meetings, that is as explicit a criticism in an official 
statement as I have ever seen.
    Senator Bayh. Well, candor can be refreshing. Beneficial at 
times, too.
    Let me shift gears to Brazil, Dr. Mussa, starting with you, 
and them Mr. Tarullo.
    You said that the markets have priced--and the status quo 
is heading us down a very dangerous path here. You said tough 
decisions will be needed. You outlined a couple of different 
alternatives.
    You are not a Government official, so you can tell us what 
you really think. Lula is likely going to win the election. 
Will he be willing to make the tough decisions that, in your 
opinion, are required to rectify the situation?
    Dr. Mussa. I am really not certain. It would be very 
difficult for him because it would require backing away from a 
number of his key campaign pledges and a number of positions 
that he has held for many years, wanting to increase public-
sector investment, wanting to do, in effect, fiscal expansion 
to generate employment, wanting to raise the minimum wage, and 
other things.
    Senator Bayh. You are talking about running a surplus of up 
to 5 percent. Is that the kind of thing that the government 
would be likely to do?
    Dr. Mussa. Well, right now, the primary surplus is a little 
below 4 percent. So it is a matter of--you have to send a 
signal that shocks the market into believing that you are 
actually going to follow a significantly different policy path 
than they are anticipating and that it is built into current 
market interest rates and prices and the exchange rate because, 
as Mark Twain observed, ``it is hard to build a reputation on 
what you are going to do.''
    So if it is a promise of what policies are going to be 2 or 
3 years down the road, it doesn't mean anything. They need to 
see you deliver it.
    Senator Bayh. Speaking of that, how did you interpret the 
dramatic and unexpected rise in interest rates yesterday?
    Dr. Mussa. The Central Bank, which has been keeping with 
the Selic rate, which is the overnight interest rate in the 
interbank market, down at 18 percent, finally had to give that 
up because the government was not able to roll its debt and the 
exchange rate was sinking through the floor. So, they kicked 
the rate up to 21 percent. That is not going to be enough. But 
it is the signal that they are running out of room. And much of 
the Brazilian debt is domestic, much of it is linked to the 
Selic rate. Once they get in the business of pushing the Selic 
rate up and it reached 45 percent in early 1999, it is going to 
be clear that fiscal sustainability is an impossibility. So the 
signal that they have already needed to take the first step 
down that road, was not a reassuring one.
    Senator Bayh. Mr. Tarullo, what is going to happen in 
Brazil and what do we need to be doing about it?
    Mr. Tarullo. Well, Mr. Chairman, like Mike I would not want 
to make a prediction, not because of an unwillingness to make 
predictions, but it is just a very difficult situation.
    Senator Bayh. Well, let me phrase my question a little bit 
differently. You pointed out that we waited a little late in 
the game to address Uruguay. Let us learn from that experience.
    Mr. Tarullo. Here is, though, what I think that we can do. 
Let us hope, and we can hope, that everything breaks right: The 
debt can be sustained without restructuring. Brazil will get 
back on a path of economic growth and there will be a strong 
and stable government.
    Having said that, we know that in the real world, things do 
not always break right. So what can we be doing right now? I 
think that maintaining the package that was put in place is a 
good idea. I think it needed to be done.
    I was disappointed in the absence of the so-called private-
sector involvement. It did not appear to me that the 
Administration or the Fund did very much to try to elicit more 
formal commitments on the part of private investors to maintain 
the rollover, or to make additional investments where 
appropriate. Instead, they accepted a rather loose--and so far 
as I can tell from people on Wall Street--not very well-
observed commitment to maintain a presence in Brazil.
    So, the first thing, I think we need to have done, and 
maybe we can still do, is to engage with the private creditor 
community.
    Second, and related to that, is my point about the 
Administration's voice itself being an instrument of economic 
policy.
    It is not dispositive. You cannot just say something and 
make it be true. But if the Administration does engage with the 
new president, whether it is Mr. da Silva or Mr. Serra (if he 
makes a comeback), and can get an understanding on a certain 
set of policies while at the same time understanding the 
political exigencies that the victor faces, then a positive 
signal will have been sent to the markets. Then the markets 
might--might--be willing to be a little bit more tolerant and a 
little bit more patient.
    If, on the other hand, you have the election of a president 
who says, ``I am going to change a lot of the things'' and the 
Administration stands back and has no voice, then I fear that 
the markets are themselves going to fear the worst, the reason 
stated in Mike's Mark Twain quote.
    Senator Bayh. So, you would argue for being more proactive, 
and it is your impression that the Administration to date has 
been a little too passive, that we should be more proactive in 
trying to define some sustainable economic policies?
    Mr. Tarullo. Exactly, Senator. As I said in the prepared 
testimony, there is a wide spectrum between imposing policies, 
on the one hand, and just sitting by the phone. I think we need 
to be somewhere in the middle, and we need to recognize that by 
being somewhere in the middle we can actually elicit a very 
positive response from the country because they know we care 
about them.
    Senator Bayh. Dr. Mussa, I am interested in your comments 
about this passivity.
    I would just make one comment of my own, Mr. Tarullo. And 
that is, if you wait to be able to, ``impose your policies upon 
another country,'' that ordinarily can only be done when the 
crisis of such magnitude, it is more difficult to correct.
    Mr. Tarullo. Excellent point, Senator.
    Senator Bayh. Yes, Dr. Mussa.
    Dr. Mussa. I think one has had to wait until the election 
is over because it is the new government that will have to make 
the decisions and implement them.
    I do not think one can impose the decision. But I think 
that one needs to pose the question clearly and starkly. There 
are no easy, attractive options. I think proceeding with the 
present fiscal surplus, which is credible and significant, the 
market says, that is clearly not enough, not marginally enough, 
woefully not enough.
    So the new Brazilian government is going to need to choose, 
do you want to do a restructuring internally and externally, 
which also involves private creditors as well, or do you want 
to go the strengthened policy path with more official backing 
and involvement of private creditors, which also involves 
backing away certainly from many of Mr. Lula's campaign 
promises.
    It is their choice.
    Senator Bayh. Either course involves backing away.
    Dr. Mussa. Absolutely. It is their choice. But the notion 
that there is this kind of easy option in the middle, that I 
think does not exist and I think that the IMF and the U.S. 
Administration need to say clearly and forcefully, that option, 
although we would like it, if it were possible, is just not 
available.
    It is your decision. It is a very tough one. And we will 
try and back you as constructively as we can once you have made 
it.
    Senator Bayh. I apologize. I am going to have to run here, 
Mr. Otteman. I do have a couple of questions for you.
    In a different context, it reminds me somewhat of the 
situation we faced in 1992. We had President Clinton coming 
into office, who had run on a modest fiscal stimulus program 
and quickly became convinced of the virtues of fiscal 
discipline, in bringing down the deficit at the time, followed 
that path with some remarkable results. But it did require a 
willingness to give up some previous statements and to turn 
against some natural constituencies. I am wondering if in our 
system, the ability to do that might be a bit greater than in 
the Brazilian political system.
    But this gets back to my points that I emphasized 
throughout, the interconnectedness of sound economic policies 
with an understanding of what is politically sustainable within 
the culture and the country that you are attempting to help, 
and you get into some difficult decisions there.
    So, as I said about the pessimist being the optimist with 
access to greater information, which is a nice segue to you, 
Mr. Otteman, you look at some of this information and it is 
very difficult to be optimistic.
    But, Mr. Tarullo, I hope that you are correct with the 
optimism that you have given us here today.
    Mr. Otteman, quickly, and I do apologize. I am going to 
literally have to run. How many American jobs do you think are 
at stake here, could be lost with more and more Americans 
depending upon exports abroad if the situation in Latin America 
continues to deteriorate? Do you have any estimates of that out 
there in the real world?
    Mr. Otteman. No, we haven't done any calculations beyond 
what the Commerce Department has done in terms of linking the 
export-related jobs to U.S. jobs.
    Senator Bayh. But if Brazil were to fall into a situation 
of real crisis, I assume it would not be insubstantial, the 
number of American jobs that would be at risk.
    Mr. Otteman. I think it would be a multiple of the 
Argentine figure that we cited in the testimony.
    Senator Bayh. This is a real-world problem that is going to 
affect real businesses in our country and working Americans, if 
we do not handle it as best we can. Correct?
    Mr. Otteman. Yes.
    Senator Bayh. This is a matter that tends to end up on the 
back pages of business sections or is of interest to 
economists. But my point is that people on Main Street are 
going to be affected if we do not get ahead of the curve here 
and learn from past experience and do a better job of trying to 
handle this one. Is that a fair observation?
    Mr. Otteman. Of course, yes. I pretty much agree.
    Senator Bayh. Last question, and I apologize for having to 
run.
    The business community has expressed some frustration about 
the lack of enough proactive intervention by the 
Administration, or attention by the Administration. What would 
you recommend? What would the NAM and its members recommend?
    Mr. Otteman. Well, we are not in the business of 
recommending really on these financial issues, at least I am 
not in a position to do that.
    Senator Bayh. Just focus on it, come up with a policy and 
implement it?
    Mr. Otteman. Exactly. I thought the discussion between you 
and the Under Secretary was very helpful, and it seemed like 
you were both on the same page when it comes down to the bottom 
line. I hope that you would continue in that direction. But we 
are just hopeful that the crisis situation can be brought under 
control so that we continue to pursue in Latin America the 
broader policies that they need both for the benefit of their 
people and that we need to be able to do business there.
    Senator Bayh. Thank you, Mr. Otteman. I apologize. I have 
been told I have one minute. I do not have on my track shoes, 
so I am going to need to move.
    I do want to thank you, gentlemen. I appreciate your 
forbearance with regard to the time and your courtesy in 
arriving. Thank you very much.
    Dr. Mussa. Thank you.
    Mr. Tarullo. Thank you, Senator.
    Senator Bayh. We have benefited from your insights.
    Mr. Otteman. Thank you.
    Senator Bayh. The hearing is adjourned.
    [Whereupon, at 12:22 p.m., the hearing was adjourned.]
    [Prepared statements supplied for the record follow:]

                  PREPARED STATEMENT OF JOHN B. TAYLOR
               Under Secretary for International Affairs
                    U.S. Department of the Treasury
                            October 16, 2002

    I would like to thank Chairman Bayh and Ranking Member Hagel for 
holding this hearing to discuss United States economic policy toward 
Latin America and the role of the international financial institutions.
    Strengthening United States ties and raising economic growth in the 
many countries of Latin America are central to President Bush's agenda, 
not only because we want to help our neighbors, but also because their 
stability is in our interest. The United States benefits directly from 
having strong neighbors and reaps tangible economic gains when the 
region fares well. But we risk losses when Latin America undergoes 
economic turmoil--not least because of the increasing integration 
within the hemisphere.
    When I testified before this Committee last February, economic and 
financial conditions throughout much of Latin America, with the 
exception of Argentina, 
appeared to be picking up after the slow growth last year associated 
with the recession in the United States and the global slowdown. 
However, since then, conditions throughout the region became more 
difficult, and economic growth this year is likely to be zero at best. 
This is in contrast to other developing and emerging market 
regions where growth is positive this year--about 6 percent in Asia, 3 
percent in Eastern Europe, and 3 percent in Africa. Clearly raising 
economic growth in the 
region must remain a high priority.

An Economically Diverse Region
    Considering Latin America as a single entity overlooks its 
diversity--from extremely poor nations confronting difficult 
development challenges to economies with sophisticated financial 
markets. Some countries in Latin America are performing well 
economically; they have implemented good economic policies. Others are 
just beginning to implement good policies, and have much to look 
forward to. Still others have recently experienced crises or are 
potentially in danger.
    Mexico and Chile's strong economic policies and sound political 
foundations have set them apart in the region. Chile remains ranked 
among the most open, competitive, and economically stable countries in 
Latin America--factors that help to 
explain its average annual growth rate of 6.8 percent throughout the 
1990's, a figure well above the regional average of 3.3 percent. After 
experiencing high inflation (70 percent annual average) and near-zero 
growth throughout the 1980's, Mexico's economy grew by an average of 5 
percent per year between 1996-2000 after its leaders had begun to 
implement a series of key free market reforms--including the North 
American Free Trade Agreement.
    A number of countries are striving to implement strong economic 
policies, but still have a way to go to realize their full economic 
potential. El Salvador stands out among those that have made tremendous 
strides by pursuing sound policies, while Bolivia, Colombia, and Peru 
are also working hard to implement a strong policy mix that will 
enhance stability.
    Other countries have experienced significant turbulence in recent 
months despite policy fundamentals that have generally been strong. The 
United States is closely watching Brazil and strongly supported IMF 
assistance in August because its economic policies have been strong. 
Events in neighboring Argentina contributed to significant difficulties 
in Uruguay this summer, but the Uruguayan authorities have responded 
strongly in cooperation with the international community.
    Finally, Argentina is beginning to stabilize though it remains in 
crisis following significant deterioration in 2000 that culminated in 
late 2001 with a freeze on bank deposits, an end to dollar-peso 
convertibility, and a default on its debt. Argentina and the IMF are 
working to conclude an agreement in the near future that will help 
Argentina to strengthen its monetary and fiscal framework.
    In the wake of Argentina's crisis, the experiences of different 
Latin American economies and other emerging markets have been 
instructive. In the months after Argentina's collapse, we saw little 
impact on other emerging market countries, even in Latin America. This 
stands in contrast to the effects of Russia's crisis in 1998, which was 
accompanied by immediate and sharp rises in the borrowing spreads for 
other emerging markets, even those that had few real links to Russia. 
It seems that in recent years investors have become more skilled at 
differentiating between countries and markets based on fundamental 
economic assessments. We have sought to promote a further evolution in 
this direction by emphasizing that policy decisions will not be based 
on unfounded claims of contagion.
    We have, however, supported programs where there was direct or 
fundamental interdependence between countries--as in the case of the 
effect of Argentina on Uruguay--in order to mitigate such effects.
Improving Prospects for Productivity Growth
    Raising living standards and expanding support for democratic 
institutions in Latin America depend critically on achieving higher 
levels of economic growth--a key concern in a region where one-third of 
the people live on less than $2 per day. The United States is working 
to help create an environment where the private sector can be the 
engine for productivity growth.
    Productivity merits special emphasis because only by raising 
productivity--the amount of goods and services that a worker produces 
per unit of time with the skills and tools available--can countries 
raise per capita income. And the higher the rate of productivity 
growth, the faster poverty will decline. Simply put, the ticket out of 
poverty is higher productivity jobs.
    Long-term trends in productivity growth have shown improvements in 
Latin America in the 1990's. According to the Inter-American 
Development Bank (IDB), the 1990's had higher productivity growth than 
the 1980's, reflecting economic 
reforms especially in the macroeconomic areas. Productivity growth was 
0.7 percent per year in Latin America in the 1990's after averaging 
less than zero in the 1980's.
    However, I am optimistic that productivity growth in Latin America 
could 
improve by a much greater amount. While productivity growth was 0.7 
percent in Latin America in the 1990's, it was 1.7 percent in the 
developed countries and 2.7 percent in the East Asian countries. That 1 
percent or 2 percent productivity difference would make a huge 
difference in living standards over time.
    The first step to raising productivity growth is gaining an 
understanding of why productivity is so low. Productivity depends on 
two things: capital per worker and the level of technology. If there 
are no impediments to the flow and accumulation of capital and 
technology, then countries or areas that are behind in productivity 
should have a higher productivity growth rate. More and more evidence 
has been accumulating that there are significant impediments to 
investment and the adoption of technology that are holding countries 
and people back.
    The United States is seeking to reduce these impediments to higher 
productivity growth by emphasizing the need for policy steps in three 
areas. As identified by President Bush these three areas are: ruling 
justly, investing in people, and encouraging economic freedom.
    First, poor governance, the lack of rule of law or enforceable 
contracts, and the prevalence of corruption create disincentives to 
invest, to start up new firms, and to expand existing firms with high-
productivity jobs. This has a negative impact on capital formation and 
entrepreneurial activity.
    Second, weak education systems impede development of human capital. 
Workers without adequate education do not have the skills to take on 
high-productivity jobs or to adopt new technologies to increase the 
productivity of the jobs they do have. There is wide agreement that 
better education is key to productivity growth. 
Although the labor force in Latin America grew at similar rates as East 
Asia in the 1990's, the rate of educational improvement was slower 
during the past decade. There are, of course, important educational 
success stories. For example, in Brazil the Bolsa Escola program, which 
provides funds to families with low incomes whose children attend 
school, has led to higher enrollments.
    Third, too many restrictions on economic transactions prevent 
people from trading goods and services or adopting new technologies. 
Lack of openness to trade, state monopolies, and excessive regulation 
are all examples of restrictions that reduce 
incentives for innovation and investment needed to boost productivity. 
For example, in Latin America on average it takes 12 legal and 
government administrative steps to start up a business. In Canada, it 
takes 2 steps to start up a business; in the United States it takes 4 
steps.
    Raising productivity rates involves steps to foster a stable 
macroeconomic environment, boost the skills of individual workers, and 
introduce market forces to help channel resources most effectively. In 
promoting these policies, however, we must remind ourselves that there 
is no shortcut to sustained economic growth and that good results 
require a patient commitment over a long period of time.

Achieving U.S. Policy Objectives
    The United States is seeking to encourage increases in economic 
growth in Latin America through an array of concrete policy steps at 
the bilateral, regional, and multilateral levels.
    President Bush signaled the U.S. commitment to bilateral efforts 
earlier this year when he proposed a dramatic increase in foreign aid 
through the Millennium Challenge Account initiative. Beginning in 2004, 
increased assistance will be available to strong performing countries--
those that govern justly, invest in their own people, and create a 
favorable climate for private enterprise--with the total increase 
reaching $5 billion per year starting in 2006. These funds provide a 
powerful incentive for countries to create an environment conducive to 
growth.
    The United States has also launched several country-specific 
initiatives, such as reform of the North American Development Bank 
(NADBank). President Bush has long recognized the need for serious 
reform of this institution. He and President Fox, who had also proposed 
reforms, decided to do something about the problem. The United States 
and Mexico established NADBank in 1993 for the purpose of helping 
border communities cope with the environmental pressures relating to 
the North American Free Trade Agreement in the United States-Mexico 
border region. But during its 7 years of operation, the overall 
performance of NADBank was unsatisfactory. NADBank had approved only 
$23.5 million and disbursed only $11 million in loans to projects, 
despite having $405 million in authorized paid-in capital and a total 
lending capacity of $2.7 billion.
    We have made much progress in the reform effort. In order to better 
use the authorized funds at NADBank, the reforms called for increasing 
the amount of support from grants and low-interest rate loans, allowing 
NADBank projects to go deeper into Mexico, merging the boards of 
NADBank and its project-certification sister institution the Border 
Environmental Cooperation Commission, and allowing retained earnings to 
fund supply-side water conservation projects on both sides of the 
border. The reforms were negotiated last spring and summer. The needed 
legislation has passed the House and is pending in the Senate.
    Another example of an initiative with Mexico is the Partnership for 
Prosperity--an initiative aimed at strengthening Mexico's economy 
through a number of measures to improve access to capital, build 
capacity, and stimulate private investment in areas that do not yet 
fully benefit from NAFTA.
    One key area that could greatly facilitate the flow of capital to 
Latin American countries involves reducing the cost of remittances sent 
from abroad. The Inter-American Development Bank estimates that Latin 
Americans living in the United States send an average of $200 to their 
native countries an average of seven to eight times per year. These 
remittances surpassed $23 billion last year--about one fifth of total 
worldwide remittances--and represent an enormous resource transfer to 
families and businesses that can make direct use of the funds. Although 
remittance charges are declining, they still range from 6 -15 percent 
of the remitted amount plus an exchange margin that ranges from 3-5 
percent. Increased competition as more and more traditional financial 
institutions offer remittance products should help to lower costs.
    Trade has enormous significance for spurring productivity gains and 
growth in the region. With approval of Trade Promotion Authority, we 
are strongly committed to rapid progress in reducing trade and 
investment barriers throughout the hemisphere. The Doha Agenda of 
global trade talks will give particular emphasis to promoting 
development. At the same time, the United States expects to sign a free 
trade agreement with Chile soon, will continue to work toward 
completion of the Free Trade Area of the Americas by 2005 as co-chair 
of the process with Brazil, and has announced the United States 
intention to begin negotiating a free trade agreement with Central 
American countries starting the first of this coming year.

The International Financial Institutions
    At the World Bank and Inter-American Development Bank, the United 
States is supporting development projects and programs that address the 
basic causes of low productivity, including projects to raise health 
and education levels, increase access to clean water and sanitation, 
and improve the climate for private sector development. A key element 
of this strategy has been the successful U.S.-led effort to have the 
International Development Association (IDA) expand the amount of grant 
financing it provides to poorer countries in order to boost development 
prospects without adding to country debt burdens. We will also continue 
our efforts to have the multilateral development banks make operational 
a system to better measure, monitor, and manage for development 
results. Measuring development results figures prominently in the most 
recent IDA round in that the agreement's contribution structure allows 
donors to increase their funding levels if concrete measurable 
results are achieved. We are convinced that donors and developing 
countries will benefit from routinely quantifying development 
achievements and understanding the reasons for success and failure.
    Within the IMF, the United States is working to strengthen 
mechanisms to detect potential crises early and act preemptively to 
address sources of vulnerability. We are also working to ensure that 
the IMF is effective in situations when a financial crisis develops. 
The IMF is most effective when it focuses on the areas central its 
expertise: monetary, fiscal, exchange rate, financial sector, and debt 
management policies. At the same time, we are working to increase 
discipline in terms of access to IMF resources to reduce the size of 
IMF packages and thereby reduce the risk of moral hazard--for example, 
the belief that in a crisis, large-scale IMF assistance will protect 
investors from the consequences of their decisions. We have also 
refrained from providing longer-term bilateral loan assistance in 
crisis cases, as was done in the past. Emphasizing that the IMF must be 
the key source of emergency support and avoiding recourse to bilateral 
assistance allows the availability of IMF resources to act as a natural 
constraint on the size of official financing packages.
    We have taken into account a number of considerations to assess 
when and whether the international financial institutions should 
provide support to countries, particularly in light of crises and other 
challenges in Latin America.
    First, and most important, countries must be committed to 
implementing credible and sustainable economic policies. Such policies 
should embrace a number of principles: strong or improving fiscal 
accounts, incentives for private sector investment in order to promote 
growth, steps to strengthen financial systems, and sound monetary and 
exchange rate policies. Not all actions can be accomplished 
immediately, of course, but it is important to begin the process as a 
means of putting economies back onto a sustainable path, as a signal of 
the authorities' intentions, and as a first step toward re-establishing 
confidence.
    Second, experience has shown that lending programs that lack strong 
ownership by a country's leaders are likely to fail; we should not 
support such programs. Narrowing the range of conditionality to 
critical issues helps increase country ownership over effective 
programs. And in the context of crisis lending, providing official 
sector support to countries with strong ownership over high-quality 
economic programs that promote economic growth is the best way to 
ensure that official sector interventions in time of crisis are laying 
the basis for a return to economic health over the long term.
    Third, it is important for the IMF and for other institutions to 
structure international financial and development packages properly so 
that strong incentives for good policy performance are maintained. 
Prior actions that must be completed 
before a lending program begins, for instance, can sometimes be a 
useful means for a country to demonstrate its commitment before 
international funds are disbursed. ``Backloading'' the financial 
assistance, with smaller amounts of money provided initially and larger 
amounts provided later on, can help to ensure that a country's 
performance does not weaken over time. Lending conditions within a 
program should also be carefully targeted, focused on those issues that 
contributed to a crisis and addressing steps that are most essential 
for future success. Not every crisis results from a fiscal deficit, for 
instance, and so not every program should automatically require fiscal 
retrenchment.

Argentina, Brazil, and Uruguay
    Let me provide an update on three of the key countries in the 
region that have received particular attention in recent months--
Argentina, Brazil, and Uruguay.
    Argentina has not yet reached a new agreement on an IMF program, 
but has recently made some progress in developing a short-term program 
to restore monetary stability. We hope that an agreement will be 
reached soon. Bush Administration 
officials, including Secretary O'Neill, have stated on numerous 
occasions both privately and publicly that we want Argentina to 
succeed. The United States has strongly supported efforts to provide 
Argentina breathing room as it works with the IMF to develop a 
sustainable economic plan. For example, the United States has backed 
four extensions this year of repayments to the IMF (totaling 
approxiamately $4.9 billion) and has also worked to accelerate lending 
from the World Bank and Inter-American Development Bank.
    But finalizing an agreement between the IMF and Argentine 
Government has not happened quickly. The extensive economic problems 
Argentina has confronted--a dramatic reduction in output, debt default, 
extensive deposit and foreign exchange restrictions, provincial 
government deficits, and a sharp depreciation of the exchange rate--
have required a significant amount of time and attention. Given the 
importance of Argentina's economy to the region and Argentina's need to 
get back on an economically sustainable path, we believe it is 
essential that Argentina's monetary and fiscal framework be 
strengthened as a basis for a new lending program. Encouragingly, in 
recent weeks, there have been some signs that parts of Argentina's 
economy have stabilized.
    For Brazil, we strongly supported the August decision to provide an 
expanded IMF lending package given confidence in the current policy mix 
and the firm belief that the short-term liquidity pressures facing 
Brazil can be alleviated through continuing such policies. Furthermore, 
the design of the program ``backloaded'' the large majority of IMF 
resources so that much of the financing will be provided only if sound 
policies are maintained. The key policy conditionality underlying the 
program includes maintenance of fiscal prudence and concrete steps to 
reform major impediments to growth such as the current tax code. 
Comments by presidential candidates in recent weeks reaffirming support 
for the main pillars of the program increase the chances of its 
success.
    In Uruguay, the United States supported a $3.8 billion official 
sector package, and drew on the Exchange Stabilization Fund to provide 
a short-term bridge loan until IFI financing could be put in place. We 
did so because Uruguay had a strong record of sound policies and we 
were convinced that the Uruguayan Government had a strategy to address 
its difficulties--particularly in the banking sector--and was committed 
to implementing that strategy.
    While we do not yet know the final outcome, initial results in 
Uruguay have been encouraging. Since the IMF program was announced, we 
have seen increased stability in the financial system and continued 
strong performance by Uruguay. Under the IMF program, net deposits in 
the nonintervened banks have increased. As a 
result of this improvement in financial sector confidence, only one-
third of the $1.5 billion in IMF resources targeted for the financial 
sector has been used. Uruguay still faces a difficult regional economic 
environment, but its leaders have shown their willingness to commit to 
necessary reforms and long-term economic goals.

Outlook for the Region
    In spite of recent turbulence, I remain confident about the 
region's prospects. First, the current economic cycle of slow or 
negative growth will improve, especially as the U.S. economy continues 
to gain strength. At about 38 percent of GDP, exports comprise a large 
percentage of income for the Latin America region as a whole.
    I believe that many countries within the region have made important 
progress over the past decade in strengthening the economic 
institutions and policies that will improve their growth prospects. In 
a number of countries, for instance, central banks have focused more on 
keeping inflation low. And many countries have abandoned soft exchange 
rate pegs and maintained floating exchange rate regimes, helping them 
to adjust more easily when faced with economic shocks. Others, such as 
El Salvador, have been successful with full dollarization.
    Across the region, the private sector now contributes a larger 
percentage of GDP than it did during the 1980's, which will help Latin 
American economies regain their dynamism more quickly. Many countries 
now have more extensive trade and financial linkages amongst themselves 
and with developed economies--such as the United States and Europe--
than they did in the past. This is a factor that will help to 
accelerate their recovery once conditions improve. Finally, Latin 
America also has a strong human capital and resource base that provides 
a solid underlying foundation for future growth.

                               ----------
                PREPARED STATEMENT OF DANIEL K. TARULLO
           Professor of Law, Georgetown University Law Center
                            October 16, 2002

    Mr. Chairman, Senator Hagel, I appreciate your invitation to 
testify today. I am currently a Professor at Georgetown University Law 
Center. As you know, between 1993 and 1998, I held several economic 
policy positions in the Administration, ending as Assistant to the 
President for International Economic Policy. I testify today purely in 
my individual capacity as an academic, with no client interests or 
representation.

What Is At Stake
    The importance of the topic of this hearing is difficult to 
overstate. If the world economy continues to stumble over the next year 
or two, much of South America may be afflicted with financial and 
business crises that produce another ``lost decade,'' such as that 
which gripped the region in the wake of the debt crisis of the 1980's.
    The human costs of that decade are incalculable in any meaningful 
sense. Yet out of that tragedy there did arise a renewed commitment in 
most countries of the region toward both democracy and market-oriented 
economic reform. By the time of the Summit of the Americas held in 
Miami in November 1994, most of the hemisphere looked forward to 
sustained economic growth. That confidence was shaken just a few weeks 
later by the onset of the Mexican financial crisis. In 1998, the spread 
of the Asian financial crisis threatened to halt the progress that had 
been achieved. Today, Argentina is losing ground rapidly, and much of 
the rest of the continent is in danger of doing likewise.
    The debt crisis of the 1980's helped convince Latin American 
countries to abandon the policies of the 1960's and 1970's that had 
laid the groundwork for crisis. Today, there is a growing sentiment in 
the region for abandoning the market-oriented policies of the 1990's 
that are blamed by many for the current difficulties. There is a real 
risk that countries in the region will fail to differentiate between 
specific policies that may indeed be tied to their financial problems, 
on the one hand, and a basic embrace of market economy policies on the 
other.
    The consequences may be very serious. First, some countries could 
revert to 
import substitution and other failed policies of the past. This would 
be a prescription for economic stagnation. Second, if economic troubles 
persist long enough, democratic institutions may themselves become 
discredited, threatening the considerable progress of the last couple 
of decades. Third, because the market reforms of the last decade are 
widely characterized as part of the so-called ``Washington Consensus,'' 
the United States may be blamed for the region's troubles. If so, 
prospects for true partnership with South American countries would be 
dashed. We might 
instead return to the bad old days of chronic mistrust and occasional 
confrontation.
    Our interests and our values are thus very much at stake. We cannot 
solve Latin America's problems. But we can, and must, adopt an 
activist, supportive set of policies to reassure these countries that 
we stand behind them and to offer, at least, the outlines of a path to 
integration in the global economy that produces sustained and equitable 
growth.

The Origins of the Current Crises
    The disheartening fact is that Argentina and Brazil, South 
America's two largest countries, are again in financial distress. 
Argentina, of course, has defaulted on its external sovereign debt. Its 
banking system has been dysfunctional for 10 months. The country is in 
severe recession, having suffered a double-digit drop in GDP over the 
last year. Brazil has, with the assistance of the International 
Monetary Fund, thus far contained the damage from the pressures on its 
currency and equity market in advance of the presidential election. But 
its position is tenuous, to say the least.
    The origins and characteristics of the Argentine and Brazilian 
travails differ in many particulars. But it is important to note that 
the recent financial histories of these countries are closely 
intertwined. The Brazilian financial crisis of late 1998 and early 
1999, itself an outgrowth of the Asian financial crisis, had a 
pronounced negative effect on the Argentine economy. Both nations have 
been seriously affected by lagging growth in European and North 
American export markets. And contrary to official expectations, 
Argentina's default on its external debt late last year has had 
contagion effects upon Brazil and other South American countries.
    So too, longer-term developments in these countries bear important 
similarities. Each returned to democratic rule less than 20 years ago. 
Each implemented a managed currency regime in the early 1990's in 
successful efforts to vanquish runaway inflation. Each is struggling 
still to escape the tendency toward lax fiscal policy that has 
afflicted them for decades. Each implemented genuine market-oriented 
economic reforms in the 1990's, and took steps to strengthen their 
banking systems. But each still lacks some of the institutional 
capacity to support and regulate effectively a market economy.
    There is considerable disagreement among official and unofficial 
observers as to the precise origins of the current crises. Indeed, the 
blame game is now being played with characteristic vigor by critics and 
defenders of the governments themselves, the IMF, and the U.S. 
Government. It seems to me that, while fair-minded people may disagree 
over the relative weights to be assigned, the chief proximate causes of 
both nations' problems are reasonably clear.
    In Argentina, three factors stand out. First, the government ran 
significant budget deficits and thus incurred substantially greater 
debt during the 1990's. Much of this sovereign debt is denominated in 
dollars and much of it is owed to foreign lenders. Running budget 
deficits in bad economic times is generally good policy. But Argentina 
increased its total public debt to GDP ratios by more than a third 
during some of its best economic years, leaving it vulnerable to debt 
servicing problems during an economic downturn.
    Second, the currency board that had been instituted a decade ago in 
a highly successful effort to tame inflation became a major source of 
distortions in the economy. This policy device, well-suited to 
inflationary times, is highly problematic during a recession. By tying 
the value of the peso to the dollar, Argentina's ability to increase 
export earnings was severely constrained during the extended period of 
dollar strength. Argentine productivity was not keeping pace with 
American productivity growth, yet the relative prices of Argentine 
products remained valued as if this were the case. At the same time, 
the currency board made borrowing in dollars seem a bargain.
    Third, the series of shocks that beset the world economy--
particularly emerging markets--beginning in late 1997 exacerbated the 
problems created for Argentina by loose fiscal policy and the albatross 
of the currency board. Slowing United States and European economies 
meant less vigorous export markets for Argentina. Flows of long-term 
direct investment dried up. The 1998 Brazilian crisis and subsequent 
devaluation of the real struck another blow to the Argentine economy, 
with its fixed exchange rate.
    By early 2001 many people--myself included--thought that the 
combination of Argentina's fiscal policy, currency board, and external 
debt position was unsustain-
able. By late 2001 nearly everyone, the IMF included, had reached the 
same conclusion. The default and devaluation of late 2001, while 
perhaps inescapable, left both the Argentine economy and political 
system in disarray. Only now, nearly a year later, do we see glimmers 
of hope that Argentina's problems may have bottomed out. Even if this 
proves to be the case, full recovery is a long ways away.
    In several important respects, Brazil's situation is different and 
more favorable than that of Argentina. Brazil abandoned its managed 
exchange rate regime in early 1999 and has thus escaped in recent years 
the shackles of the strong dollar. Brazil has significantly reformed 
the fiscal relationship between state and federal governments that has 
so bedeviled Argentina. Indeed, Brazil has recently been running a 
primary budget surplus of between 3 percent and 4 percent of GDP 
(although its debt servicing costs are so high that it still has a 
substantial bottom-line budget deficit).
    Unfortunately, Brazil's situation resembles that of Argentina in 
two important respects. First, Brazil's public sector debt rose 
dramatically during the 1990's. In fact, Brazil's public debt increased 
faster than Argentina's, nearly doubling during the decade, to about 60 
percent of GDP. While this borrowing is less dollar-denominated and 
external than Argentina's, Brazil's external exposure is still 
sufficiently high (about 40 percent of total public debt) that it was 
vulnerable to changes in international capital market conditions and 
sentiment. Second, like Argentina, Brazil has been buffeted by the 
cumulative effects of South American economic problems and by uncertain 
prospects for global growth.
    Finally, of course, the growing prospect of a change in Brazil's 
ruling coalition has, throughout the last several months, applied 
enormous pressure on Brazil's currency and equity markets. As Mr. Da 
Silva's election prospects brightened, culminating in his leading the 
vote-getting in the first round of elections, markets became edgier. Da 
Silva's commitment to significant social change and policy stances in 
earlier elections have unnerved some investors, notwithstanding his 
repeated commitments to honor Brazil's debt obligations.

The Role of the IMF
    Consideration of the role of the IMF in the Argentine and Brazilian 
situations is perhaps best divided into discussion of: (1) the Fund's 
short-term decisions to provide or, eventually in the case of 
Argentina, not to provide assistance programs; and (2) medium-term 
issues concerning the wisdom of the Fund's advice to, and monitoring 
of, emerging markets.

Decisions on Stand-By Credits
    The Fund's decision to provide a stand-by arrangement for Argentina 
in late 2000 was a questionable one, which has since been characterized 
by some from the outgoing Clinton Administration and the Fund itself as 
a close call one way or the other. It was difficult to see how 
Argentina's fiscal situation could feasibly and sensibly be reversed 
quickly enough to render its external debt obligations sustainable. 
Adding more multilateral debt seemed the triumph of hope over 
experience.
    If the 2000 program was questionable, then the additional 
assistance program 
announced in the summer of 2001 was simply mistaken, as the Fund itself 
now essentially acknowledges. Renegotiation of Argentina's external 
debt, abandonment of the currency board, or both were clearly required. 
Perhaps a Fund package accompanying such measures would have had a 
chance of success, though one suspects it may have been too late to 
pull off a reasonably smooth landing. By the end of 2001, the Fund had 
reconsidered. It made no further assistance available to an Argentine 
government unable to meet its external debt payments and beset 
internally by rising popular anger.
    The decision not to provide further assistance for the muddling-
through efforts of the Argentine government is certainly defensible. 
What seems less defensible, at least to an outside observer, was the 
apparent withdrawal of the Fund (and the United States) from the field. 
While Fund officials continued to make sympathetic noises about a 
willingness to help Argentina, it was hard to discern proactive efforts 
to assist in organizing a dialogue with creditors or in formulating a 
set of interim policy measures that would contain Argentina's downward 
slide and accelerate an economic turn-around. It may well be that the 
political situation in Argentina was by November 2001 so chaotic as to 
foreclose any coherent policy response by the government. If so, the 
mistake in having provided stopgap programs in late 2000 and mid-2001 
is all the more telling.
    In the case of Brazil, the Fund offered what I consider to be a 
very successful program for Brazil in December 1998. Indeed, in 
retrospect that program and Brazil's own economic management look to 
have been the turning point in the financial crisis that had started in 
Asia and was spreading to other regions. Brazil abandoned its exchange 
rate regime in the early stages of this program. As the 1998 stand-by 
arrangement was expiring, the Fund offered another program in September 
2001, largely on the basis of unfavorable external developments. The 
Fund conditioned the program on achievement of primary surplus targets.
    Late last summer the Fund reached the sound conclusion that 
investor uncertainty in advance of the presidential election could 
itself lead to financial crisis, regardless of the policies eventually 
followed by the new president. By announcing a program that had a large 
``headline'' number but that withheld most of the assistance until 
after the new administration's policies become clear, the Fund was 
attempting a delicate balancing act. I agree with the Fund's effort to 
strike this balance and hope its formula succeeds.
    My reservation about the program as announced was that it was 
unaccompanied by any formal private sector actions. If Brazilian 
policies, the world economy, and investor sentiment all break the right 
way, Brazil's situation may stabilize and its external debt may become 
sustainable. Given the size of that debt and the reality of a teetering 
world economy that may soon be shaken by major military conflict, I 
worry that debt rescheduling may be necessary. My own predisposition 
would have been to include some form of private sector involvement--
such as commitments on net capital inflows in the medium term--in the 
initial plan, so as to enhance chances for its success. If 
restructuring becomes necessary in the coming months, further financial 
disruption is essentially inevitable.

The Fund's Advice and Expectations
    It is very difficult for the Fund to escape criticism in the case 
of Argentina. The Fund has had multiple programs over several decades 
with the country. Moreover, as is now regularly pointed out, through 
much of the 1990's the Fund praised 
Argentina as an exemplar of privatization, market-oriented reform, and 
financial stability. Something was obviously wrong or missing in the 
Fund's prescriptions.
    Yet it is important not to jump from this observation to the 
conclusion that every policy the Fund recommended was unsuitable or 
that its recommendations were the chief causes of the 2001 financial 
implosion. I should quickly note that I have certainly disagreed with 
Fund policies in the past, whether general or country specific. Up 
until quite recently, the Fund was on a campaign to eliminate all of 
the controls on capital inflows, with no more than nominal attention to 
the capacity of a country's financial system to absorb big inflow 
surges. The Fund's sometimes reflexive emphasis on fiscal tightening 
even in the midst of fiscal distress has often been inappropriate. Fund 
endorsement of privatization without regard to transitional and 
ownership arrangements can be ill-advised in some circumstances.
    But privatization--whether well or poorly conceived--did not cause 
Argentina's financial crisis. And the Fund's response to Argentina's 
fiscal policy which is most susceptible to criticism is its failure to 
insist on more fiscal discipline during years in which economic 
performance was relatively good. Or, what amounts to a variation on 
this theme, perhaps the Fund should have pressed Argentina to limit its 
external sovereign borrowing. Likewise, the Fund might be criticized 
for not urging Argentina to abandon its currency board, since one of 
the principal lessons which the Fund drew from the Asian financial 
crisis is that a fixed exchange rate in an environment of free capital 
flows vastly increases the risk of financial crisis in emerging 
markets.
    In assessing the Fund's dealings with Brazil, one might similarly 
criticize the Fund's acquiescence in the rapid increase in sovereign 
debt levels. Here, though, the criticism is less justified. In 1998, 
Brazil was a kind of firewall against the further spread of financial 
crisis. Insistence upon greater fiscal austerity in that period would 
have been counterproductive. Indeed, the Fund would have itself been 
subject to the recurring criticism that is pithily summed up in the 
witticism that IMF stands for ``It's Mostly Fiscal.'' By 2001, the Fund 
was conditioning a program on maintenance of a significant primary 
budget surplus.
    Like Argentina in 2001, Brazil's exchange rate regime had helped 
create the conditions for crisis in 1998. Export earnings were 
artificially restrained by an overvalued currency, and short-term 
dollar debt was artificially attractive. Some have charged the IMF with 
the responsibility for Brazil's imposition of a crawling peg exchange 
rate in 1994. It may be fair to say that the IMF was once too tolerant 
of fixed exchange rate regimes--a position that it has now changed. But 
it does not accord with my understanding to say that the IMF urged a 
fixed-rate regime upon Brazil in 1994 (or, for that matter, upon 
Argentina in 1991). On the contrary, at least at the staff level there 
were serious misgivings about this policy step by Brazil.
    What conclusions can we draw about the role of the Fund from the 
recent Argentine and Brazilian experiences? I believe these experiences 
reinforce one fundamental point and raise one fundamental question.
    The fundamental point is that a presumption of private sector 
involvement should obtain whenever the IMF approves a sizeable stand-by 
credit to assist countries unable to service their sovereign debt. 
Usually the private sector involvement will be important for achieving 
a sustainable program for the country. Private sector involvement will 
always be important for creating a set of incentives for lenders and 
borrowers that are more closely correlated with the risks actually 
involved in specific debt transactions. The nature of the private 
sector involvement can and should vary with the particular 
circumstances of the debtor country. Sometimes commitments to maintain 
existing levels of exposure will be adequate. And sometimes 
rescheduling may be appropriate. Less frequently, some reduction in the 
debt stock itself may be necessary. But in all cases the private sector 
involvement must be real rather than specific. That means the 
development and publication of satisfactory, precisely-stated terms.
    The fundamental question raised by the Argentine and Brazilian 
experiences is the degree to which we want the IMF to assume 
responsibility for the economic policies of emerging market countries 
with actual or potential debt problems. It should be clear from the 
preceding discussion that the rectification of possible IMF mistakes 
would have come only at the expense of substantial infringement on the 
sovereign decisions of a democratically elected government. Should IMF 
officials have pressured Brazil in 1994 not to adopt the pegged 
exchange rate? Should the Fund decide when a country should stop 
borrowing abroad? Should the trade-off between containing runaway 
inflation now and the risks of debt and currency imbalances later be 
made by the elected representatives of the people or by the Fund?
    These are not easy questions. Uncorrected national policies may 
lead to requests for sizeable IMF stand-by credits. When a country is 
in crisis and seeking substantial international resources, some 
imposition of conditions is inescapable, as in any lender-borrower 
situation. Earlier reform would obviously be preferable. It is 
certainly incumbent upon the IMF to sound private and, in unusual 
circumstances, perhaps even public warnings about unsustainable 
national policies. How far the member states of the IMF want the Fund's 
staff to go in forcing policy decisions upon countries not in immediate 
crisis seems to me a subject in need of substantially more exploration 
and debate.

The Role of the Administration
    It is apparent from the foregoing discussion that the situation in 
Argentina was already deeply troubled when the Administration took 
office in January 2001. The agenda for reforming the so-called 
international financial architecture had stalled. Quite frankly, the 
problems in the international financial system are not susceptible of 
quick and easy solutions, so one can hardly criticize the 
Administration for failing to solve those problems in less than 2 
years. But, I regret to say, having been dealt a bad hand, the 
Administration has not played that hand particularly well.
    The voice of a U.S. economic official is itself an important 
instrument of policy. A consistent, measured, and coherent voice 
establishes credibility, reassures market actors, and enhances U.S. 
economic leadership. The absence of such a voice has just the opposite 
set of consequences. While I think it unfair to hold the Administration 
responsible for all the financial problems faced by emerging markets, I 
think it is legitimate to criticize the lack of consistency, coherence, 
and restraint in its statements and actions.
    When the Administration took office, it proclaimed the end of large 
IMF ``bail outs.'' Although many were skeptical that such a blunt 
policy approach was optimal, it was certainly a clear position. The 
Administration's endorsement of a program for Turkey did not appear a 
real departure from this position, since most people understand that 
there is an implicit ``security exception'' to any stated international 
economic policy.
    But the misguided program for Argentina and the defensible programs 
for Brazil and Uruguay have obviously undermined completely the 
Administration's stated policy position. The current Administration 
view appears to be that it will not support ``unsustainable'' IMF 
programs. I do not think one can find any Administration that has ever 
stated its support for unsustainable IMF programs. In the absence of a 
clearer policy statement, it is hard to know where exactly the 
Administration stands.
    Similarly, with respect to reforms of the international financial 
system, just a few months ago the Administration publicly rejected IMF 
proposals for a sovereign debt restructuring mechanism (SDRM), in favor 
of voluntary terms in bond indentures. Again, one might agree or 
disagree with that position. Yet just a few months later the 
Administration appears to have endorsed the IMF plan. While one should 
always be mindful of Ralph Waldo Emerson's observation that ``a foolish 
consistency is the hobgoblin of little minds,'' it is not reassuring to 
see the Administration walk away from a strongly stated position with 
no explanation of why its views had changed.
    The relative passivity of the Administration during and after 
financial crises has also been disappointing. I understand and 
appreciate the Administration's view that it cannot impose solutions on 
Argentina or any other country. But it seems to me both ill-advised 
foreign policy and wasteful economics to have simply stood by and 
waited for Argentina to come up with an acceptable plan. Things are 
only made worse when Administration officials make off-handed comments 
critical of the country suffering through the crisis. The confusion and 
uncertainty attending a financial crisis afflict all participants. 
Generally speaking, an active role by the United States is necessary 
for expeditious movement along the path to a solution. There is a wide 
spectrum running between efforts to impose economic policies and 
sitting by the phone waiting for the Argentines to call. I would 
suggest that the better U.S. position is somewhere in the middle of 
that spectrum.
    I am glad that the Administration has eschewed the simplistic 
solutions to complex financial problems that some have urged upon them. 
But the complexity and seriousness of problems require the exercise of 
leadership. While the U.S. agenda for international financial reform 
may have to be developed and implemented in stages, with continuing 
refinements, our direction and aims should be clearly stated and 
consistently advanced. The retreat of the United States from a clear 
leadership position on the problems of specific countries and on the 
broader issues of reform is costly as a matter of both foreign and 
economic policy.

Conclusion
    At the risk of repetitiveness, let me end where I began. It is very 
much in the U.S. interest that the rest of this hemisphere consist of 
well-established democracies that produce equitable economic growth for 
their peoples. While there will always be good-faith differences of 
view as to the most appropriate U.S. policies in support of these ends, 
there can be little doubt that an active presence in attempts to solve 
national and regional problems is imperative. To me, this imperative 
means both a more visible presence in efforts to reverse Argentina's 
economic slide and a more consistent, active leadership role in efforts 
by the international community to address systemic international 
financial problems.

                               ----------
               PREPARED STATEMENT OF MICHAEL MUSSA, Ph.D.
          Senior Fellow, Institute for International Economics
                            October 16, 2002

    Thank you, Mr. Chairman and Members of the Subcommittee.
    It is a pleasure to participate in this timely hearing concerning 
the difficult economic situation in Latin America and the efforts of 
the United States and the international community to ameliorate these 
difficulties.
    This year, Latin America is suffering from its worst economic 
performance in nearly two decades, with real GDP for the region 
projected to drop by 2 percent--the largest decline since the darkest 
days of the debt crisis in 1983. Argentina is an economic catastrophe, 
with real GDP expected to fall a further 15 percent this year to 
roughly 25 percent below its 1998 peak. Uruguay is also in a severe and 
prolonged recession, facing a decline of another 8 to 10 percent in 
this year's output. Hit by domestic political turmoil, Venezuela's 
economy will probably shrink about 5 percent this year.
    Other countries in the region are not faring as badly; but none are 
doing well. Brazil, which has the region's largest economy, will be 
lucky to achieve 1 percent real economic growth this year--following 
upon 4 years where the average annual growth rate has been well below 
Brazil's potential. More importantly, Brazil now teeters on the brink 
of a major financial crisis that--if not averted--would push next 
year's growth sharply negative. Even the region's best consistent 
economic performer, Chile, faces another year of distinctly subpar 
growth. And Mexico, the region's second largest economy and the Latin 
American economy that has by far the most important economic linkages 
to the United States, will probably grow by less than 2 percent this 
year and remains at very significant risk if the U.S. economic recovery 
loses forward momentum. Thus, as general background for this hearing, 
it is relevant to recognize that the present economic situation in all 
of Latin America is not good, and there is considerable concern that it 
may not get much better anytime soon.
    Of course, several important factors have contributed to Latin 
America's present economic difficulties and to the risks going forward, 
with the most relevant factors differing considerably across individual 
countries. The global economic slowdown and the weakening of many 
commodity prices have had a negative impact on exports from the entire 
region. Diminished inflows of direct foreign investment to Latin 
America have also partly reflected the weaker worldwide investment 
climate. Meanwhile, conditions in world financial markets have turned 
distinctly less hospitable toward emerging market borrowers--a factor 
of particular importance for relatively heavy indebted Latin American 
countries. And, negative spillovers within the region have also been 
important for some countries, most notably the severe negative 
consequences for Uruguay of the economic catastrophe in Argentina.
    Despite the clear importance of such external factors, however, the 
most important causes of Latin America's present distress lie in 
domestic economic weaknesses and in how these weaknesses have 
interacted with adverse external developments. This is especially so in 
Argentina where (as I have argued elsewhere) the combination of a very 
rigid exchange rate regime and persistent imprudence in fiscal 
management ultimately led to a disastrous economic and financial 
crisis.\1\ A similar story applies to Brazil's present predicament. A 
large build-up of net public debt (from 30 percent of GDP in 1994 to 
over 60 percent of GDP today) and a large external financing 
requirement (relative to merchandise exports) for the combined public 
and private sectors have made Brazil particularly vulnerable to an 
adverse change in financial market sentiment that now threatens to make 
sovereign default and/or systemic private default a self-fulfilling 
prophecy. Indeed, even for Uruguay where adverse external shocks have 
undoubtedly played a particularly large role in present difficulties, 
the high vulnerability to these adverse shocks was seriously 
exacerbated by the large prior build-up of public debt and the 
substantial foreign exchange risk exposure of Uruguay's financial 
system.
---------------------------------------------------------------------------
    \1\ See Michael Mussa, Argentina and the Fund: From Triumph to 
Tragedy, Policy Analyses in International Economics, No. 67, Institute 
For International Economics, Washington, DC, July 2002.
---------------------------------------------------------------------------
    Clear recognition that Latin America's present difficulties and 
challenges reflect primarily domestic weaknesses and vulnerabilities 
that have been significantly exacerbated by adverse external 
developments is essential to understanding the particular issues that 
are the main focus of this hearing. The international economic and 
financial system does not function perfectly, and its malfunctioning is 
partly responsible for the instability now gripping much of Latin 
America. Confusion and inconsistency in the policies of the United 
States Government and of the official international community 
(particularly the International Monetary Fund) have, in my opinion, 
contributed to the malfunctioning of the system and, accordingly, have 
made the problems of Latin America somewhat more difficult than they 
might otherwise have been. Conversely, a more sensible and consistent 
set of policies of the international community to address potential and 
actual crises in emerging market countries--with credible leadership 
and support from the United States--could help Latin America emerge 
more rapidly and successfully from its present travails. Nevertheless, 
the principal tasks of managing the present difficulties, reducing the 
likelihood of their recurrence, and laying the foundation for a more 
prosperous future necessarily lie with Latin Americans themselves.
    With this general principle in mind, I turn to address three 
specific issues raised in the letter of invitation to this hearing. 
First, what is my understanding and 
assessment of the United States Administration's policy concerning so-
called ``bailouts'' of emerging market countries facing actual or 
potential financial crises, especially as how it relates to Uruguay and 
Brazil? Second, what is my evaluation of the approach that the IMF has 
taken in the cases of Uruguay and Brazil, in comparison with that 
adopted in the recent case of Argentina? Third, what should the 
international community attempt to do about problems of sovereign (or 
systemic) bankruptcy?

United States Policy Toward Large-Scale Official Support
    Perhaps there is, somewhere, a very careful explanation of the 
present U.S. Administration's general policy toward official financial 
support for emerging market countries facing financial crises. Perhaps 
this statement somehow rationalizes the rhetoric which suggests that 
the policy is to oppose ``large-scale bailouts'' and the facts which 
show actual Administration support for official support packages on a 
scale and at a pace that dwarfs past efforts in this area. As a more 
than casual observer of these matters, however, I am befuddled by the 
glaring inconsistency between the Administration's words and actions; 
and I am far from the only one to suffer this confusion.
    There has been little ambiguity about the Administration's 
rhetoric. In line with the analysis and recommendations of the majority 
of the Meltzer Commission, even before it took office, many of those 
who now hold positions of responsibility for economic policy in the 
present U.S. Administration voiced their opposition to ``large-scale 
bailouts'' of countries facing financial crises and of these countries' 
creditors. After a year and a half in office, the Administration's 
rhetoric on this issue has changed little--beyond the recognition that 
there may be ``special cases'' where large-scale official support may 
be appropriate and that new mechanisms for dealing with sovereign 
bankruptcies should be implemented or at least studied.
    The facts, however, belie this rhetoric. Within barely 3 months of 
taking office, the Administration supported a large expansion (about 
$10 billion) of the already significant official support package for 
Turkey from the International Monetary Fund. This raised IMF support 
committed to Turkey to over 1,500 percent of its IMF quota, in 
comparison with a normal (cumulative) access limit of 300 percent of 
quota. Nine months later, after the tragedy of September 11 emphasized 
the geopolitical importance of Turkey, the Administration endorsed a 
further massive 
expansion of IMF support for Turkey (about another $12 billion). This 
raised IMF support committed to Turkey to about $31 billion or roughly 
2,800 percent of 
Turkey's IMF quota. In absolute amount, as a ratio to IMF quota, and 
relative to Turkey's GDP (of about $200 billion), this was by far the 
largest amount of IMF support ever committed to a single country up to 
that time.
    In August 2001, the Administration supported an $8 billion increase 
in IMF financing committed to Argentina, on top of the $20 billion of 
official support (from the IMF, World Bank, IDB, and the government of 
Spain) that had been committed in early January. This raised the ratio 
of official support committed to Argentina to GDP to a level that was, 
up to that time, exceeded only by the combined support committed by the 
U.S. Treasury and the IMF to Mexico in early 1995.
    In September 2001, the Administration also participated in the IMF 
decision to extend about $15 billion in precautionary financial support 
to Brazil, in light of risks of contagion from the deepening crisis in 
Argentina. The committed IMF 
support, available for disbursement over a period of 15 months, 
amounted to 400 percent of Brazil's IMF quota, compared with a normal 
annual access limit of 100 percent of quota When, in the face of 
sharply deteriorating market sentiment, Brazil drew the bulk of this 
previously committed support in July 2002, Secretary O'Neill initially 
indicated strong United States opposition to any further IMF support 
for Brazil. This opposition, however, was soon reversed; and in August 
the United States Administration supported the commitment of an 
additional $30 billion of IMF support for Brazil, raising total 
committed IMF support to a new absolute record for a single country 
(but as a ratio to Brazil's GDP only about half that of Turkey).
    For Uruguay, an IMF program with about $750 million of committed 
financing (about 200 percent of Uruguay's IMF quota spread over 2 
years) was established in March 2002, succeeding an earlier program 
with about $200 of committed support. It soon became apparent, however, 
that this moderate level of support was woefully inadequate to meet a 
crisis involving massive withdrawals from Uruguay's banks and 
corresponding capital outflows. With strong encouragement from the 
United States Government, official support committed to Uruguay has now 
been raised to $3.8 billion or about 20 percent of Uruguay's GDP. This 
puts little Uruguay at the top of the league table--displacing Turkey--
as the country with the highest ratio of committed official support to 
GDP.
    It might reasonably be argued that geopolitical considerations, 
especially in the aftermath of September 11, make Turkey a special case 
that merits significantly larger official financial support than would 
normally be appropriate--just as geopolitical considerations plausibly 
argued for somewhat special treatment of Russia during the 1990's. 
However, it is difficult to see how important geopolitical 
considerations weigh in the case of Uruguay. More generally, with six 
cases during its first 20 months in office (Turkey in February 2001, 
Argentina in August 2001, Brazil in September 2001, Turkey again in 
February 2002, Uruguay in June and again in 
August 2002, and Brazil again in September 2002) in which the 
Administration has endorsed large international support packages for 
emerging market countries, it is nonsense to suggest that the 
Administration has a consistent policy of opposing such packages.\2\ 
The Administration's rhetoric says something that its actions strongly 
contradict.
---------------------------------------------------------------------------
    \2\ In large support packages, there has been greater reliance on 
IMF's financing and less reliance on bilateral official financing than 
before 2001. In particular, there has been nothing similar to the $20 
billion of bilateral official support that the United States Treasury 
extended to Mexico in 1995-1996. Nevertheless, looking at total 
commitments of official support (excluding the phony commitments in the 
so-called second lines of defense), the scale of recent commitments of 
official support, relative to any relevant standard, has been larger 
recently than in the past.
---------------------------------------------------------------------------
    Has this inconsistency done real damage? I fear it has, in at least 
three ways.
    First, officials in other countries have been confused and, in some 
cases, offended by the inconsistencies in U.S. rhetoric and actions. 
Quite rightly, many in Brazil (and many elsewhere in Latin America) 
took umbrage at Secretary O'Neill's remarks this summer criticizing 
official support for Brazil as a waste of the hard earned money of 
United States citizens to finance capital outflows from Brazil to Swiss 
bank accounts. Brazil has always repaid its official financial 
support--so that there is no reason to suggest that such support, 
whatever it might be used for, ultimately comes at the expense of 
United States citizens. Moreover, this summer Brazil was facing severe 
pressures on its currency because of capital outflows related to a 
general decline in market confidence. No doubt, this included capital 
outflows by Brazilian residents; but it also primarily reflected 
cutbacks in external credits to Brazil and a falloff in direct foreign 
investment into Brazil. In this situation, negative comments by the 
U.S. Treasury Secretary were certainly not helpful in restoring 
confidence--even if they were not a principal cause of Brazil's 
difficulties.
    Second, for the international community to play a constructive role 
in dealing with emerging market financial crises, it needs to behave in 
a reasonably predictable manner and in accord with a reasonable set of 
principles and policies. This is essential for both the governments of 
emerging market countries and for the creditors of, and investors in, 
these countries (both foreign and domestic) to be able to function in a 
responsible and stabilizing manner. Obviously, circumstances will 
differ in individual cases, and no precise blueprint can be established 
for how all possible contingencies will be handled. Some amount of 
``constructive ambiguity'' may also be useful. However, the 
international community needs to set reasonable rules of the game that 
can be understood by it various participants--or the already difficult 
problems of emerging market financial crises will be even more 
difficult. In this important area of international affairs, as in most 
others, constructive leadership from the U.S. Government is essential. 
Ideologically based policy rhetoric that is fundamentally and 
transparently contradicted by policy actions does not supply such 
leadership.
    Third, actions speak louder than words; and judging by the 
Administration's 
actions, there is a relatively wide array of circumstances where large 
packages of international financial support (beyond the normal access 
limits of IMF support) need to be considered as part of the response to 
emerging market financial crises. In what circumstances should such 
support packages be considered? How should they be structured? When 
should they be augmented? When should they be terminated? These are 
critical questions of judgment that the international community needs 
to be able to address. And the answers to these questions that are 
stated as the policy of the international community need to be 
reflected in the actions taken in individual cases; and conversely. 
This point was emphasized by Peter Costello, the Treasurer (Finance 
Minister) of Australia in his remarks to the September 28 meeting of 
the IMF's International Monetary and Financial Committee:

        ``. . . what counts is what the Fund actually does rather than 
        what it says it will do. Ultimately, it is the quality of the 
        judgments that are taken in each case and whether the 
        frameworks are applied consistently, which will determine 
        whether the Fund is successful in helping to resolve crises. In 
        effect, each decision will be part of the ongoing process of 
        defining the role and success of the Fund. It is important that 
        its actions are consistent with its stated intentions. This has 
        not always been the case.''

    Indeed, I believe that this is part of the explanation of what went 
wrong in the misguided decision to expand IMF support to Argentina in 
August 2001--a decision that I have characterized as the worst single 
mistake of the IMF during the past decade. In December 2000, the IMF 
agreed, with the full participation of the outgoing United States 
Administration, to a large international aid package for Argentina in 
order to provide the Argentine authorities with one last opportunity to 
avoid sovereign default and a disastrous economic and financial crisis. 
Everyone knew that there was significant risk that this effort might 
not succeed, especially if the Argentine authorities failed to carry 
through on their commitments to achieve moderate additional fiscal 
consolidation. But to those who saw large support packages as 
appropriate in some circumstances, the risks seem to be worth it, 
especially in view of the alternative.
    With earlier large support packages, there had also been 
significant risks of failure, and some actual failures. Allowance for 
this possibility was made in how the packages were designed and/or 
implemented. In Mexico, in early 1995, the policies of the Mexican 
authorities initially proved inadequate to halt a collapse of 
confidence and catastrophic depreciation of the peso. Appropriate 
strengthening of these policies, backed by continued commitment of 
large-scale international support, was essential to achieve success. In 
Korea in December 1997, a rapid run-off of international bank credits 
threatened to overwhelm the government's modest reserves and available 
official financing, thereby forcing a catastrophic financial collapse. 
Facing up to this challenge, on Christmas eve, the policy strategy was 
changed; the major industrial countries moved to encourage their 
commercial banks to roll over their Korean exposures, with the backing 
of guarantees from the Korean government. The new strategy stemmed 
reserve losses and helped to reestablish stability. In Russia in the 
summer of 1998, the size of the initial IMF disbursement in a large 
official support package was cut back when the Duma failed to pass key 
legislation required under the IMF program, and the support package 
lapsed after the first disbursement when the Russian authorities 
defaulted and devalued. In Brazil in the autumn of 1998, a large 
official support package backed a stabilization program that, at the 
insistence of the Brazilian authorities, sought to preserve that 
country's crawling peg exchange rate regime. In view of substantial 
doubts about the viability of that exchange rate regime, however, the 
support package did not permit unlimited use of these resources to 
defend the exchange rate. When the policies of the Brazilian 
authorities proved inadequate to sustain market confidence, the 
exchange rate regime collapsed. As a condition for continued official 
support, Brazil then had to move to a floating exchange rate regime. 
Thus, in all of these cases where large support packages were used, the 
possibility of failure was recognized (at least implicitly), and 
approaches to deal with this possibility were considered and 
implemented.
    In Argentina by the summer of 2001, it was clear that the 
stabilization effort was failing and there was no reasonable 
expectation that the Argentine authorities could implement policies to 
correct the situation. Without commitment of additional official 
support of at least $30 billion--something that the official community 
was not prepared to contemplate--sovereign default and collapse of 
Argentina's convertibility plan had become unavoidable. Understandably, 
the Argentine authorities were loath to recognize this fact. But the 
leaders of the international community (at the IMF and in key finance 
ministries) should have known better. Augmenting the support package 
for Argentina and disbursing another $6 billion of IMF financing in 
early September 2001 was a stupidity. The collapse was merely postponed 
by a few weeks, Argentina was stuck with $6 billion more of official 
debt that it now finds very difficult to repay or reschedule, and 
potential opportunity to manage the inevitable collapse in a less 
catastrophic manner was lost.
    To what extent did general disdain of senior U.S. officials for 
large official support packages contribute to the serious mismanagement 
of this particular support package. It is difficult to know, especially 
because relatively limited practical inexperience with these issues 
probably also played a role. However, common sense suggests that those 
who are ideologically opposed to large international support packages 
are probably not very well prepared to manage them effectively. By 
analogy, while we do not want war mongers as our military leaders, a 
conscientious objector is not suitable as Commandant of the Marine 
Corps. If the United States endorses an international system that uses 
large packages of official support as part of the mechanism for dealing 
with emerging market financial crises--as is implied by the actions of 
successive U.S. Administrations--then the responsible U.S. officials 
need to understand and appreciate both the uses and the limitations of 
this tool of international economic policy.

Uruguay and Brazil
    Uruguay is a small country with a GDP of only about $20 billion, 
less than a one-tenth of the size of the Argentine economy and barely 3 
percent of the size of the Brazilian economy.\3\ Because of its small 
size, I normally do not pay much attention to Uruguay. However, because 
of Uruguay's close economic linkages to Argentina (and to a lesser 
extent to Brazil), it was clear even to me that Uruguay was in for 
serious trouble (on top of an already ongoing recession) as Argentina's 
crisis deepened over the course of last year. This judgment was clearly 
shared by most of the relevant staff at the IMF. The report for the 
annual Article IV consultation with Uruguay (dated September 21, 2001) 
emphasizes that ``. . . Uruguay is highly vulnerable to further shocks 
in the region.'' [Emphasis in original.] Nevertheless, nothing special 
was done last year to help Uruguay contend with the adverse spillovers 
that were obviously likely to come from Argentina, other than 
continuing with a modest IMF program (with support of about $200 
million or about 50 percent of Uruguay's IMF quota spread over 22 
months) that had been established in May 2000.
---------------------------------------------------------------------------
    \3\ Large fluctuations of exchange rates over relatively short time 
periods can change dramatically the dollar value of the GDP of emerging 
market countries. In the medium term, however, real exchange rates (for 
example, exchange rates adjusted for movements in national price 
levels) are relatively stable. The dollar values of countries' GDP's 
referred to in this statement 
reflect what the GDP is at normal values of exchange rates when the 
economy is operating near its potential. For Argentina, GDP is about 
$250 billion, for Brazil it is about $600 billion, for Uruguay it is 
about $20 billion, and for Turkey, it is about $200 billion. In 
comparison, U.S. GDP is about $10 trillion.
---------------------------------------------------------------------------
    With the existing IMF program due to expire at end March 2002, 
negotiations for a new program were underway during the winter of 2002. 
They concluded with an agreement (approved by the IMF Executive Board 
on March 25, 2002) that committed about $750 million of IMF support 
spread over 2 years. This amount was almost at the upper limit of 
normal access for Uruguay to IMF resources. Nevertheless, I believe 
that the technical staff at the IMF understood from the start that this 
new program fell far short of what was likely to be needed to help 
Uruguay successfully confront its impending crisis--mainly but not 
exclusively the result of contagion from Argentina. Whatever might have 
been the views of the technical staff, however, the management of the 
Fund and the Fund's major shareholders were not, at this point, willing 
to contemplate yet another IMF program beyond the normal access limits.
    A special characteristic of Uruguay is that it has a large banking 
system relative to the size of its economy, with assets of public and 
private banks amounting to about 50 percent of GDP. Most of the 
liabilities of the banking system are denominated in or indexed to the 
U.S. dollar, and a substantial part of bank deposits are held by 
nonresidents (mainly Argentines). Banks maintain large foreign-exchange 
assets to offset their foreign-exchange liabilities, but are 
nevertheless exposed to considerable risk from sharp depreciation of 
the peso against the dollar. Uruguay also has a substantial public 
debt, and the ratio of public debt to GDP has risen rapidly since 1998 
as the economy has been in recession and the government's fiscal 
position has deteriorated. The decision to double (to 15 percent per 
year) the rate of depreciation of the peso against the dollar in June 
2001 was necessary in view of the deterioration in Uruguay's internal 
and external economic situation; but, as a portent of troubles to come, 
this did not ease concerns about the banking system or the rising 
public debt ratio.
    In spring 2002, the problems latent in Uruguay's economic and 
financial situation began to deepen. Large outflows of bank deposits, 
including substantial outflows by nonresidents, put downward pressure 
on the exchange rate and rapidly ate into both the liquid foreign 
assets held by public and private banks and the central bank's foreign 
currency reserves. Facing huge reserve losses it soon became necessary 
to allow the peso to float (for example, sink) against the dollar. By 
late May, a new IMF mission was on its way to Uruguay with the 
announced intention of 
negotiating a substantial augmentation of IMF support. In mid-June, 
Deputy Managing Director Eduardo Aninat announced that IMF management 
would endorse an increase of IMF support for Uruguay of about $1.5 
billion--bringing total committed IMF support to over 600 percent of 
Uruguay's IMF quota, more than double the normal cumulative access 
limit.
    As most of the technical analysts suspected, even this large new 
commitment of IMF support was not enough to contain Uruguay's deepening 
crisis. In early August, IMF Managing Director Horst Kohler announced a 
further augmentation of IMF support committed to Uruguay--this time, 
about another $500 million. The World Bank and the Inter-American 
Development Bank (IDB) would also chip in increases in their support, 
bringing total official support committed to Uruguay to $3.8 billion, 
or roughly one-fifth of Uruguay's GDP.
    However, even at this stage, it is still unclear whether the large 
amount of official support will be enough to enable Uruguay to resolve 
its financial difficulties without a restructuring either of its public 
debt or of the assets and liabilities of most of its banking system. 
Indeed, despite repeated augmentations of its financial support, the 
international community has never really faced up to the fundamental 
questions of whether, and under what policies and conditions, Uruguay 
can successfully emerge from its present crisis without a comprehensive 
debt restructuring, or whether a comprehensive debt restructuring is 
not, in fact, an essential part of the solution of Uruguay's 
difficulties. Rather, the strategy seems to have been to throw more and 
more money at the problem in the hope that it will go away--perhaps 
with the recognition that what is a lot of money for Uruguay is not all 
that much from the perspective of the international community.
    In summary, my view is that the performance of the international 
community in its efforts to assist Uruguay during the past 9 months 
fell considerably short of the best that one might reasonably have 
expected. Tiny Uruguay was facing a major potential financial crisis--
mainly reflecting contagion from Argentina. From the start, it was 
clear that moderate levels of official support, within normal access 
limits, would clearly not be adequate to forestall the crisis. Only 
massive official support or a very painful restructuring of Uruguay's 
public debt and financing system would do the job. The international 
community, however, was not prepared to face up to this choice. It 
dithered. As the crisis deepened, significant official support was 
pledged, but not enough to be entirely convincing. The result has been 
that large-scale support that might have been sufficient to resolve the 
problem if fully 
committed at the start has instead still left significant risk of 
further troubles. Moreover, even with a record ratio of official 
support to GDP, it is still unclear whether the strategy will work for 
Uruguay, or whether a resolution involving comprehensive debt 
restructuring might be either better than what has been done and/or 
still necessary.
    In the case of Brazil, I believe that the performance of the 
international community has been much better, notwithstanding important 
mistakes by the U.S. authorities. Recognizing that Brazil might suffer 
adverse spillover effects from Argentina's crisis, a precautionary IMF 
program was established in September 2001. Under this program, Brazil 
progressively accumulated the right to draw up to about $15 billion of 
IMF resources, under the condition that it maintain a responsible 
fiscal policy (with a primary budget surplus of at least 3\1/2\ percent 
of GDP). The objective was to reinforce confidence in Brazil's economic 
policies both by supplying an important supplement to Brazil's own 
foreign exchange reserves (of $30 billion to $40 billion) and by 
providing the monitoring of an IMF program to help assure that critical 
economic policies remained on track.
    Nevertheless, there clearly remained a significant risk that a 
financial crisis might beset Brazil. To demonstrate that this risk was 
anticipated, not merely recognized in hindsight, I quote from my 
International Economics Policy Brief on ``Prospects for the World 
Economy: From Global Recession to Global Recovery,'' released as PB02-
02 by the Institute for International Economics in early April 2002.

        ``The major question for Latin America (aside from the 
        uncertainties about Argentina) is the likely performance of the 
        Brazilian economy--which accounts for 40 percent of Latin 
        America's GDP. . . . The key question for Brazil is whether 
        growth will reaccelerate as global growth recovers, or whether 
        uncertainties arising from the October elections and spillovers 
        from Argrentina may provoke a crisis of confidence in the 
        sustainability of Brazil's debt dynamics, leading to another 
        economic downturn.
        ``The fact is that, for an emerging-market country, Brazil has 
        a relatively high ratio of public debt to GDP. Most of this 
        debt is either quite short-term, has floating interest rates 
        that adjust rapidly to movements in short-term market rates, is 
        denominated in foreign currency, or has some combination of 
        these features. This implies that if for any reason (including 
        rising doubts about Brazil's ability to meet its debt service 
        obligations), interest rates on Brazilian debt rise or the 
        foreign exchange value of the real [Brazil's currency] falls, 
        Brazil's debt service burden and/or the ratio of debt to GDP 
        will rise--contributing to worries that debt dynamics may be 
        unsustainable. Moreover, Brazil has a relatively small share of 
        exports in GDP and, accordingly, is dependent on a continuing 
        inflow of foreign capital to finance a significant current 
        account deficit and also to finance a continuing rollover of 
        substantial foreign indebtedness. Thus, apart from possible 
        concerns about the stability of public sector debt dynamics, 
        there are also potential concerns about the financing of 
        Brazil's external payments. If confidence is lost in either of 
        these key areas, a crisis would likely ensue . . .
        ``As an optimist, I assume that the chances are three to one 
        that Brazil will navigate through the difficulties of 2002 
        without a crisis . . .''

    Unfortunately, this optimism was short lived. During May, opinion 
polls began to show a significant lead for the Worker's Party 
presidential candidate, Luis Ignacio Lula da Silva (Lula) and 
relatively weak support for the candidate of the ruling coalition, Jose 
Serra. This provided a trigger for increased market concerns about what 
might happen in Brazil after the election. The interest rate spread on 
Brazilian Brady bonds, which had stood at about 700 basis points above 
U.S. Treasuries in early April, began to rise and breached 1,000 basis 
points in June. The real came under downward pressure as foreign 
creditors began to cut back their Brazilian 
exposures and Brazilians scrambled for foreign exchange to meet debt 
service obligations and pay for the trade deficit.
    During the summer, as Lula's poll results remained strong and 
Serra's results generally weakened, the crisis deepened, with interest 
rate spreads widening to 2,000 basis points and with the real sinking 
to well beyond 3 to the dollar (versus about 2.3 to the dollar at the 
start of the year). While shifting poll results clearly influenced 
these developments, the true underlying cause was the vulnerability in 
Brazil's public debt and external payments positions and the problem of 
``multiple equilibrium'' that these vulnerabilities generated. John 
Williamson, my colleague at the IIE presents a very useful and 
insightful analysis of this problem in his International Economic 
Policy Brief, ``Is Brazil Next?'' issued as PB02-07 by the Institute 
for International Economics in August.
    Under the general assumption that the Brazilian government 
continues to run a responsible fiscal policy with a primary budget 
surplus of 3\1/2\ to 4 percent of GDP, there are two possible outcomes 
for Brazil's public debt dynamics: stable and un-
stable. If people believe that the debt dynamics are stable, then the 
holders of Brazilian government debt (both domestic and foreign) will 
probably be satisfied with real interest rates on this debt 7 to 8 
percent. These would be very high real interest rates for an industrial 
country like the United States, but in line with what real interest 
rates have been in Brazil and in many other emerging market countries. 
At this level of real interest rates, experience suggests that the 
Brazilian economy can grow in line with its potential--a real GDP 
growth rate of perhaps 4 percent. In this situation, starting with a 
public debt to GDP ratio of 60 percent, a primary budget surplus of 
3\1/2\ to 4 percent of GDP would be sufficient to put the debt to GDP 
ratio on a downward path. Thus, confidence that public debt dynamics 
are sustainable leads to the result that they will be sustainable.
    On the other hand, if people believe that the Brazilian government 
cannot successfully manage its finances without restructuring the 
public debt, they will demand high real interest rates to compensate 
for the risk of the losses they will take in the event of a 
restructuring. At a real interest rate of 10 percent, with a debt to 
GDP ratio of 60 percent and a real GDP growth rate of 4 percent, it 
takes a primary budget surplus of 4 percent of GDP just to stabilize 
the debt to GDP ratio. At real interest rates above 10 percent, public 
debt dynamics are unstable (without an increase in the primary budget 
surplus). Higher real interest rates also reduce the likely growth rate 
of the Brazilian economy which worsens prospects for debt 
sustainability. Most importantly, by making debt sustainability less 
likely, higher real interest rates promote even higher real interest 
rates in a vicious cycle. At present, interest rate spreads on Brazil's 
external foreign currency debt imply real interest rates above 20 
percent.\4\ There is no doubt that these interest rates embody a very 
substantial premium for the risk that the Brazilian government may have 
to restructure its debt. If in coming months confidence is not somehow 
restored and interest rates are brought well down from present levels, 
debt restructuring will become a self-fulfilling prophecy.
---------------------------------------------------------------------------
    \4\ Real interest rates on Brazil's internal debt are significantly 
less than 20 percent. In particular, about half of the domestic debt is 
denominated in domestic currency and bears interest at a rate directly 
linked to the interbank overnight rate, the Selic rate. The Central 
Bank has been holding the Selic rate at 18 percent. With inflation now 
running at least 5 percent and probably headed upward, the real 
interest rate on the Selic linked domestic debt is in the range of 10 
to 12 percent. But, without the imposition and effective implementation 
of stringent capital controls, the Central Bank will not be able to 
keep the Selic rate down at 18 percent if market interest rate spreads 
on Brazil's external dollar-denominated debt remain above 20 percent or 
even 15 percent. Indeed, the Brazilian government is already 
encountering difficulty in the auctions in which is seeks to roll over 
its (relatively short-maturity) Selic-linked debt. Eventually, if 
market determined real interest rates on Brazil's external debt remain 
very high, domestic real interest rate will rise to meet them.
---------------------------------------------------------------------------
    Of course, the preferred outcome from this multiple equilibrium 
situation would be for confidence in debt sustainability to produce 
that result (assuming that the Brazilian government continues to 
deliver a very responsible fiscal policy. John Williamson and many 
others argue that this is the economically appropriate solution that 
the market should either naturally seek this solution or be pushed 
toward it. While I appreciate this position, I also tend to share the 
skepticism of one of my other IIE colleagues, Morris Goldstein.\5\ 
While sometimes fickle, the market is not completely nuts. After 
several years of large private capital inflows and official acclaim for 
its economic policies, Argentina has recently defaulted on a large 
volume of public debt. The situation in Brazil is in some respects 
(relatively high public debt and a high ratio of external liabilities 
to exports) similar to that in Argentina. And despite recent official 
praise for Brazil's sound policies, the policy track record is not 
entirely reassuring.
---------------------------------------------------------------------------
    \5\ Mr. Goldstein's analysis of Brazil's situation and the likely 
need for a comprehensive debt restructuring were presented in a public 
lecture, ``Is a Debt Crisis Looming in Brazil,'' at the Institute for 
International Economics on June 22, 2002. The main points are 
summarized in an op-ed column, ``Brazil's unwatched borrowing,'' in the 
Financial Times, August 29, 2002.
---------------------------------------------------------------------------
    In particular, during the 8-year tenure of President Cardoso, the 
net public debt to GDP ratio has risen from 30 percent to over 60 
percent. In addition, the government has spent large privatization 
revenues. Part of the increase in net public debt is explained by the 
recognition of previous off-the-books losses or ``skeletons'' and, 
especially recently, by the sharp increase in the domestic burden of 
dollar-denominated or dollar-linked debt arising from the large 
depreciation of the real. But not yet all of the skeletons have 
emerged; and the choice that the Brazilian government made to issue 
dollar-linked debt clearly involved substantial contingent liabilities 
that are now being manifest at a particularly embarrassing time. Thus, 
in Brazil, the market knows that it has something to worry about, and 
sweet talk is not going to be enough to persuade it otherwise.
    What has the international community done to help Brazil in its 
deepening predicament? Having met the conditions for its September 2001 
IMF program, in July, Brazil exercised its accumulated rights to draw 
on IMF resources to the tune of about $14 billion. More importantly, 
the IMF agreed to a new stand-by arrangement (formally approved and 
announced on September 6, 2002) that committed about an additional $30 
billion of IMF support to Brazil, subsequently supplemented by 
additional commitments from the World Bank and the IDB. The new IMF 
program provided only an additional $3 billion immediately and 
committed another $3 billion for potential disbursement before year 
end; and it reserved the remaining $24 billion for potential 
disbursement during 2003, conditional on the new Brazilian government 
maintaining responsible fiscal and monetary policies. The objective of 
the new IMF program was two fold: to provide Brazil with some 
additional resources to help meet near-term market pressures (mainly by 
allowing Brazil to utilize an additional $10 billion of its own foreign 
exchange reserves); and to help restore market confidence by assuring 
significant additional IMF support based on continued sound policies.
    Market reaction to the initial announcement of the new IMF program 
(in August) was positive, but this lasted for barely a day. Markets 
soon figured out that the new program had not significantly altered the 
fundamentals of Brazil's economic and 
financial situation nor the uncertainties associated with the upcoming 
election.
    Nevertheless, I believe that this new program was the right 
approach in the circumstances. Unlike Argentina by the summer of 2001, 
the situation in Brazil is not (yet) hopeless; and comprehensive 
restructuring of Brazil's public debt and probably most of its private 
debt is not (yet) inevitable. The Brazilian elections (which will 
necessarily bring a change of government), however, are a critical 
barrier to taking the key decisions about what strategy to adopt to 
deal with Brazil's present predicament. The present Brazilian 
government is unwilling to contemplate debt restructuring because it 
sees it as unnecessary and highly destructive, and probably also 
because it realizes that restructuring would signal the failure of the 
policies of the past 8 years. On the other hand, the present Brazilian 
government cannot credibly commit to policies that will remove the risk 
of restructuring; the responsibility for the design and implementation 
of such policies belongs to the next Brazilian government. That new 
government will not be determined until the elections are finished. 
Before the elections, no sensible candidate wants to contemplate and 
certainly not talk about the possibility of a debt restructuring. And 
it is very difficult to be specific and credible concerning policies 
that may be needed to avoid restructuring when no one even wants to 
admit that such a terrible thing is possible.
    In this situation, delay of critical decisions until after the 
Brazilian elections has been the only available and desirable option--
even if such delay came at the cost of a few more billions of Brazil's 
dwindling foreign exchange reserves and some further shortening to the 
maturity of the government's debt. Once the elections are over, 
however, critical decisions will soon need to be made. In view of the 
calendar for debt refinancing, this cannot wait until the start of the 
2003 when the new Brazilian government formally takes power. Key 
members of the new economic team will need to be designated before mid-
November. The new government-to-be will urgently need to begin to make 
clear the main elements of its policy approach, and will also need to 
begin to build political support to enact and implement the needed 
policies--as it prepares to assume office. The first few months in 
office then will become critical for establishing whether the new 
government will be successful in putting its policies in place and what, 
under these policies, Brazil's economic future will look like.
    What are the relevant policy strategies for the new Brazilian 
government and what role should the international community play in 
supporting them? I believe that there are two distinct policy 
strategies worth considering, with the middle ground between being 
essentially untenable.
    Unfortunately, the untenable middle ground appears to be what is 
intended in the most recent IMF program for Brazil. As I understand it, 
this program envisions a respectable policy effort that would keep the 
primary budget surplus at just below 4 percent of GDP and maintain a 
monetary policy targeted at keeping inflation in the low single digits. 
There would be no effort to press the private sector, inside or outside 
of Brazil, to do anything special to support the stabilization effort. 
Official support would amount to the sums already committed by the IMF, 
World Bank, and IDB. The problem is that the situation in one where 
restoring market confidence is the critical issue. The market is 
already well aware of existing IMF program, and the market clearly 
judges it to be inadequate--not just marginally inadequate, but very 
substantially inadequate. While it is possible that, after the 
elections, for some unforeseeable reason, there would be a large 
spontaneous recovery of market confidence, it seems foolhardy to base 
Brazil's economic strategy on this thin hope. The result is likely to 
be that after another $10 billion to $25 billion of official support is 
disbursed to Brazil and frittered away in vain efforts to avoid 
default, the collapse will come. Then, in a disorderly way, virtually 
denuded of reserves and of international support, Brazil will undertake 
a messier-than-necessary debt restructuring. Probably it will not be 
quite as bad; but it will look much like Argentina all over again.
    On one side of this untenable middle ground is a basic policy 
strategy that recognizes that, because of highly negative market 
sentiment and limited ability of the Brazilian government and the 
international community to act sufficiently forcefully to substantially 
improve this sentiment, comprehensive debt restructuring is practically 
unavoidable. The effort would then be to manage this restructuring with 
as little damage as possible. This would be no easy task. The 
comprehensive debt restructuring would necessarily include both the 
Brazilian government's external and internal debt. In addition, the 
assets and liabilities of Brazil's financial system would probably need 
to be restructured, as would most of Brazil's private external debt. To 
accomplish all of this without profound damage to the Brazilian 
economy, as well as to its Brazil's domestic and external creditors--as 
has happened in Argentina, would be a daunting task.
    To complete this task with minimum unnecessary damage to all 
concerned will require continued sound fiscal and monetary policies. 
Use of already committed official financial support would also be 
important--but to help smooth out the inevitable difficulties of 
comprehensive debt restructuring, rather than blow it away in further 
futile efforts to delay a necessary restructuring. The result would 
probably still be a sharp negative shock to the economy (and to the 
government's public support); but if handled constructively, a 
comprehensive debt restructuring need not necessarily lead to a 
disaster of the magnitude of Argentina.
    The other viable policy strategy is to adopt a vigorous, all-fronts 
effort to create a situation where comprehensive debt restructuring is 
not needed and clearly perceived as not needed. In my view, at a 
minimum, this requires that the Brazilian government credibly commit to 
fiscal policies that will raise the primary budget surplus to at least 
5 percent of GDP (under reasonable economic assumptions) and maintain 
the surplus at this level at least until the debt to GDP ratio declines 
below 55 percent. A primary surplus of at least 4 percent of GDP should 
be maintained at least until the debt to GDP ratio declines below 50 
percent. [The first objective could be met quite rapidly if the 
strategy is credible and appreciation of the real reduces the domestic 
currency value of Brazil's dollar and dollar-linked debt.] The policy 
strategy should also include responsible measures to persuade 
Brazilians both that they should be satisfied with reasonable real 
interest rates on the large volume of domestically held Brazilian 
government debt and that they should refrain from large-scale capital 
flight. Brazil's foreign creditors should also be officially 
encouraged--in their own self-interest and as their essential 
contribution to an ambitious stabilization effort--to behave 
responsibly in maintaining and restoring their credit exposures to 
creditworthy customers. For its part, the official international 
community should pledge its continued financial support to Brazil--at a 
higher level than has already been committed, and clearly conditioned 
on stronger policy commitments from the Brazilian authorities and with 
some meaningful measures to assure constructive behavior by the private 
sector inside and outside Brazil.
    How much additional official support might be contemplated? For a 
truly strong and credible stabilization effort with a good chance of 
success, it does not pay to be chintzy. Official support committed to 
Uruguay (which may not be enough) is at 20 percent of GDP. If official 
support for Turkey is augmented again next year (as I think likely), 
that too will rise to about 20 percent of GDP. For Brazil, official 
support at the level of 20 percent of GDP would amount to about $120 
billion, somewhat more than double the substantial amount that has 
already been committed to Brazil. This sounds like--and is--a very 
large amount of money, reflecting the fact that Brazil has a large 
economy. Arguably a more modest commitment of official support, around 
$100 billion would be enough. However, in the business of large-scale 
official support packages, a key point to remember is that moderately 
large packages backing moderately strong programs tend to result in 
moderately large disbursements and program failures. Large support 
packages backing very strong programs are often not fully disbursed and 
generally lead to success. As General MacArthur observed about war, in 
the large package business, ``There is no substitute for victory.''
    To be clear, I do not advocate war as the solution to all political 
differences among nations. Nor do I advocate large official financing 
packages as the answer to all potential and actual emerging market 
financial crises--including the crisis presently unfolding in Brazil. I 
raise the possibility of increasing official support for Brazil to the 
range of $100 billion to $120 billion primarily to dramatize a key 
point--directly relevant to the issues posed for this hearing. Consider 
the established policy, backed by the implicitly present U.S. 
Administration in the actions recently taken in the cases of a small 
country, Uruguay, and a moderately large country, Turkey. Apply this 
same policy consistently to a very large emerging market country, 
Brazil. What do you get? A package of international support that is 
truly enormous!
    Would it be a good idea to proceed with such an enormous support 
package for Brazil? Even someone who believes, as I do, that large 
international support packages are appropriate in some circumstances 
would be compelled to say, ``Better think long and hard before doing 
that one.'' \6\ The general point is that similar careful thought 
should go into all cases where the potential scale of official support, 
relative to the size of the country, is quite large. The merits in all 
of these cases need to be weighed carefully because they set the policy 
of the international community. The approach adopted for a small 
country where large official support relative to the size of the 
country is comparatively modest in absolute terms sets a precedent for 
the approach that should be followed, in principle, for a much larger 
country where the absolute scale of official support could be enormous.
---------------------------------------------------------------------------
    \6\ IMF resources alone are probably not adequate to finance 
commitments of another $40 billion to $60 billion to Brazil. Even for 
the IMF's contribution, it would probably be necessary to activate the 
New Agreements to Borrow (NAB) under which the IMF can borrow 
additional resources from key members. Also, official bilateral 
contribution would probably be needed to finance a large augmentation 
of the package for Brazil. All of this, hopefully, would help to focus 
the minds of those who control the IMF on what they are trying to do 
and on the appropriate means for accomplishing it. The IMF should not 
shield high officials from their responsibility.
---------------------------------------------------------------------------
    Consistent with the general policies that I believe should apply in 
such cases, I would recommend that commitment of substantial additional 
assistance to Brazil (or disbursement of much of the remainder of what 
has already been committed) should be undertaken only under tight 
conditionality. Specifically, the new Brazilian government must 
prepared to commit to policies that raise substantially the likelihood 
that comprehensive debt restructuring can be avoided. The acid test 
that these policies be sufficiently forceful that they go a 
considerable distance toward restoring confidence in financial markets 
to a degree that induces a large reduction of interest rates without 
which fiscal sustainability is impossible.
    It is far from clear that the new Brazilian government will want 
to, or be able to, undertake such policies. This would surely require 
backing off from key campaign pledges like hikes in minimum wages and 
large new public investment programs. It would require measures to cut 
public spending and/or raise revenues that would undoubtedly face 
fierce political opposition. But the only other viable strategy--which 
will lead sooner or later to comprehensive debt restructuring--is also 
surely no bed of roses. The new Brazilian government will have to make 
some very tough choices--and quite quickly. Only if the government 
decides to pursue policies that provide the essential basis for a 
strategy that avoids comprehensive debt restructuring should the 
international community entertain the possibility of supporting this 
strategy with commitments of significant additional support. Brazil 
must not be another case, like Argentina, where large official support 
is disbursed and frittered away because the officials of the country 
and the officials of the IMF and its leading shareholders are not 
prepared to face up to reality and to their 
responsibilities.
    Moreover, the international community, and especially the IMF, 
really cannot afford a big failure in Brazil. After the crises in Asia 
and Russia and the debacle in Argentina, the credibility of, and public 
support for, the IMF have been seriously damaged. Institutional 
recovery after another big failure would probably be very 
difficult.
    Indeed, the IMF's own finances are a growing matter of concern. For 
many years, there have been a few countries that have fallen into 
prolonged arrears on their obligations to the IMF. But the total amount 
of these arrears has remained relatively small. Now in the aftermath of 
the Asian crisis, Indonesia is in a situation where it has a large 
amount of IMF credit (about $8 billion) and where there is some 
question about when it may be able to begin substantial net repayments 
to the Fund. For Argentina (with about $14 billion of IMF credit 
outstanding), the issue is more immediate--without an agreement on a 
new IMF program which effectively rolls over most of the large payments 
coming due during the next year, Argentina will probably be forced to 
go into arrears to the IMF and to the World Bank and the IDB. For 
Turkey, there is already a large volume of IMF credit outstanding, and 
the amount appears likely to continue to increase for some time and 
probably quite substantially. Where and when Turkey will get the 
resources to begin substantial repayments to the IMF remains an 
interesting question. For Uruguay, IMF credit already outstanding (now 
about $1.5 billion) is not that large in absolute amount, but if 
Uruguay became unable to make scheduled repayments to the IMF, this 
alone would about double the amount of IMF credit that is now formally 
in arrears.
    If Brazil (which already has about $17 billion of IMF credit 
outstanding) were to go the way of Argentina, there might well be 
another large chunk of IMF lending that either goes into arrears or 
needs new programs just to roll over obligations to the IMF. If Brazil 
does follow this course, large further disbursements to Brazil in the 
near future will only make the problem of the IMF's finances that much 
worse.
    In the long-run, I doubt that countries like Indonesia, Argentina, 
Turkey, Uruguay, or Brazil will fail to repay their obligations to the 
IMF. But there is still a rising risk that an important part of the 
IMF's resources will be tied up with a few countries that are unable to 
repay in a timely matter. This would seriously hamper the ability of 
the IMF to respond to the needs of its other members and to play its 
proper and intended role in the international monetary and financial 
system. It would also contradict the letter and spirit of the IMF's 
Articles of Agreement. Members' use of IMF resources is supposed to be 
``temporary,'' and that IMF programs are supposed to contain adequate 
safeguards to assure that use of the IMF's resources is, in fact, 
temporary. If these principles are violated on a substantial scale, 
then the IMF is not fulfilling its important responsibilities, and 
those primarily responsible for its stewardship, both inside and 
outside of the institution, are failing in their primary 
responsibilities.

Sovereign Default and Debt Restructuring
    One of the proposals for helping to deal with emerging market 
financial crises that has recently received much attention is the 
suggestion of creating a sovereign debt restructuring mechanism (SDRM) 
through an amendment of the IMF's Articles of Agreement. A SDRM would 
provide an internationally approved set of procedures for a sovereign 
debtor in default (or potential default) on its obligations to reach an 
agreement with its creditors to restructure its obligations in a manner 
that would plausibly allow it to meet its new obligations while 
treating its various creditors in a responsible manner. Under such an 
SDRM, the existing rights of creditors to sue in national courts to 
seek recovery of their claims would be suppressed (at least for some 
period) and would be superseded by an agreement between a qualified 
majority of creditors and the sovereign on a debt restructuring.
    Anne Krueger, the First Deputy Managing Director of the IMF, has 
been at the forefront of those suggesting that a SDRM is needed and 
desirable. A good deal of work on this issue has now been done by the 
IMF staff, which is reported on the IMF's website at www.imf.org. The 
issue has been discussed by the IMF's Executive Board. At its meeting 
on September 28, 2002, the IMF ministerial committee, The International 
Monetary and Financial Committee, directed that work on this issue 
should continue with the objective of examining specific proposals at 
its meeting next April. The IMFC, however, has not endorsed the 
establishment of a SDRM. Beyond ministerial endorsement, establishment 
of a SDRM would require approval and ratification by members 
representing 85 percent of the voting power of the IMF--including 
formal ratification of an amendment to the Articles of Agreement by the 
U.S. Congress
    It is essential to understand that present proposals for a SDRM 
would apply sovereign debt issued by all members of the IMF, but only 
to debt of sovereigns issued under foreign law. Sovereign debt issue 
under domestic law (which is the vast majority of sovereign debt, 
particularly for industrial countries like the United States) would not 
be covered. Official loans to sovereigns by other governments and by 
the international financial institutions would be excluded from the 
SDRM. The SDRM would also not apply to other (nondebt) obligations of 
the sovereign whether contracted under domestic or foreign law. Also, 
the SDRM would not apply to private debts or other contractual 
obligations, whether within a country or across national boundaries, 
regardless of the legal jurisdiction of the contract. These limitations 
are vitally important because they clearly imply that there are many 
important issues in typical emerging market crises that a SDRM does not 
address at all.
    Of course, one might consider a systemic restructuring mechanism 
(SRM) that would address the restructuring of all of a country's 
obligations, domestic and foreign, debt and nondebt, and public and 
private, regardless of questions of legal jurisdiction. Such a 
monstrosity, however, would be inconsistent with the most basic 
principle of the present international order--the principle that 
sovereign nations are responsible for the management of their own 
internal affairs. When a sovereign and its creditors chose to write 
their debt contracts subject to the law of another country, it is 
reasonable for that other country and for the international community 
to establish some rules for how defaults should be handled. It is quite 
another thing for the international community to assert the right to 
intervene in a sovereign's treatment of its domestic debt or into 
disputes among private contracting parties. This would imply 
extraordinary authority for the international community to intervene 
into the economic, financial, and legal affairs of sovereign nations, 
potentially including the overruling of national laws, court decisions, 
and even provisions of national constitutions.\7\ Most countries would 
rightly and strenuously object to such intrusions; and the 
international community would be exceedingly unwise to consider any 
mechanism that would systematically involve it in such intrusions. (As 
my colleague on this panel, Professor Tarullo, is better qualified to 
discuss this particular issue, I will leave further comment to him.)
---------------------------------------------------------------------------
    \7\ Under the conditionality associated with IMF programs, 
countries are often required to undertake policies requiring 
legislation or even constitutional modification. But an IMF program is 
negotiated with a country's authorities who are free to reject the 
program and its conditionality if they so choose. A SRM that applied 
universally to IMF members, regardless of their wishes in individual 
cases, would represent a much greater infringement of the principal of 
national sovereignty.
---------------------------------------------------------------------------
    Arguably, a SDRM limited to the foreign-law debt of sovereigns 
would improve on present procedures for resolving sovereign defaults. 
Take the case of Argentina--which involves by far the largest default 
by an emerging market sovereign on its foreign-law debt. Excluding 
bonds held by Argentine institutions (where the legal status is 
somewhat obscure), there the Argentine government has about $50 billion 
(face value) of foreign-law bonds outstanding, spread over more than 80 
separate issues, and at least 5 different legal jurisdictions. Some of 
the bond issues have collective action clauses which allow a qualified 
majority of bondholders to agree to a restructuring and impose its 
terms on all holders of that issue. Many of the bonds, however, follow 
U.S. legal practice and require that each bondholder preserves the 
right to pursue legal action for collection unless he individually 
agrees to a restructuring. Clearly, resolving Argentina's sovereign 
default on its foreign-law debt will be a legal nightmare that is 
likely to take many years to conclude.
    If it were applicable to Argentina, a SDRM along the lines that has 
been discussed within the IMF would help to cut through at important 
part of this legal nightmare.\8\ Existing legal requirements would be 
suppressed, and qualified majorities of the holders of all separate 
bond issues would be able to agree to restruc-
turings of their particular issues. A qualified majority of the holders 
of all the bonds would (through means that I do not entirely 
understand) be able to agree to an overall restructuring. This would 
still leave difficult problems of actually reaching agreement within 
and between different groups of bondholders and between bondholders and 
the sovereign. But individual bondholders and small groups of 
bondholders would have much less latitude than at present to disrupt an 
agreement and/or to stay out of an agreed restructuring in order to 
pursue their claims independently.
---------------------------------------------------------------------------
    \8\ A newly created SDRM probably could not be applied on an ex-
post basis to Argentina. But consideration of how a SDRM would work in 
this case is very useful for consideration of what a SDRM might 
accomplish in cases where it would apply.
---------------------------------------------------------------------------
    Granted that a SDRM might proved helpful securing more orderly 
restructurings of sovereign foreign-law bonds when they fall into 
default, should creating a SDRM be a high order priority for reform of 
the international financial system? I have been, and I remain, highly 
skeptical. Whatever might be its advantages or disadvantages in 
resolving sovereign defaults, there is no credible reason to believe 
that a SDRM would meaningfully reduce either the likelihood of emerging 
market financial crises or the severity of such crises when they occur.
    Anyone who doubts the validity of this bold assertion should read 
carefully the literature on the SDRM (especially that recently produced 
at the IMF) to find the detailed analysis of how a SDRM would have 
materially reduced the frequency and severity of the many emerging 
market financial crises that we have seen in the past decade. There is 
no such analysis. Instead, the sense of urgency for consideration of a 
SDRM has been built on two concerns: (1) existing legal procedures do 
not 
provide an orderly and reliable means for resolving sovereign defaults 
on their foreign-law bonds; and (2) there has been a lot of highly 
damaging emerging market financial crises in recent years. But is there 
any meaningful link between these concerns--a link that is absolutely 
essential to establish an urgent case for a SDRM. A little reflection 
on the facts clearly indicates that there is no such link.
    Take the present crisis in Argentina. Among the major emerging 
market financial crises of the past decade, this is the only case where 
sovereign default on a large volume of foreign-law debt has actually 
occurred. Undoubtedly Argentina is now undergoing a severe economic and 
financial crisis. Real GDP is down 15 percent from its year ago level 
and is down about 25 percent from its peak in 1998--the worst output 
drop suffered by Argentina in this century and surely one of the worst 
suffered in all of Latin America. But what has the default of the 
Argentine sovereign on its foreign-law debt contributed to this 
catastrophe? And what would a SDRM have done to lessen this damage? To 
both questions the answer is--practically nothing. Default on Argentine 
government debt held by Argentine banks has played some role in the 
collapse of the Argentine banking system, but this debt has effectively 
been transformed into domestic-law debt. As far as the sovereign's 
foreign-law debt is concerned, the Argentine government has simply 
stopped paying both the interest and the principal. Bondholders have 
complained. A few have filed suits in European courts; but foreign 
courts have not authorized seizures of Argentine assets. More 
generally, actions by Argentina's disgruntled foreign bondholders have 
simply not played any significant role in Argentina's present economic 
disaster.
    Down the road, of course, it is possible that difficulties in 
restructuring Argentina's foreign-law debt will create problems for the 
Argentine economy. When might these problems come and how severe might 
they be? No one can know for sure, but experience and common sense 
suggest that the problems probably will not come soon and, relative to 
Argentina's present difficulties, will likely not be that severe. In 
particular, the case that is cited as exemplary of the problems that 
can arise in the absence of a SDRM is the case of Elliot Associates v. 
Peru. In this case, many years after the Peruvian government had 
defaulted on some foreign-law bonds, a hold-out creditor was able to 
secure a court judgment enforcing payment under the original terms of 
the debt contract. This cost the Peruvian government some money, but it 
had no significant negative impact on the performance of the Peruvian 
economy. The example of Elliot Associates may encourage hold-out 
creditors in the case of Argentina; and this may delay and complicate 
negotiations over debt restructuring and ultimately cost the Argentine 
government some money. However, negotiations over debt restructuring 
will probably drag out for some time in any event, and payments to 
hold-out creditors are likely to be even further in the future--by 
which time the Argentine economy will hopefully have enjoyed 
substantial recovery.
    Sovereign defaults on foreign-law debt have also occurred recently 
for some 
smaller emerging market economies, notably Ecuador and Ukraine; and 
Pakistan has recently restructured much of it foreign-law debt. I am 
not an expert on these cases, but my general impression is that 
restructuring has proceeded relatively smoothly, despite the absence of 
a SDRM. A much larger and more complicated sovereign default, such as 
that of Argentina, might ultimately prove much more difficult to 
resolve. But, so far, the fears about the extreme difficulties of 
sovereign debt restructuring in the absence of a SDRM, and especially 
about the great damage likely to be done to the countries involved, 
have not proved to be well founded.
    Looking to the major emerging market crises of the past decade, 
other than the present crisis in Argentina, sovereign default on 
foreign-law debt simply did not play a significant role.\9\ 
Specifically, in the Mexican crisis of 1995, the main problem was an 
overvalued exchange rate and difficulties in rolling over the tesobonos 
(domestic-law debt) and international credit lines to Mexican banks 
(private debts). In the Argentine crisis of 1995, sovereign default was 
not a serious risk. In Thailand's crisis of 1997-1998, the problem was 
an overvalued exchange rate and actual or 
potential defaults on foreign credits extended to Thai financial 
institutions and corporations. In Indonesian, the problem was credits 
extended to Indonesian corporations by both foreign and domestic 
financial institutions. In Korea, the problem was an over-leveraged 
domestic corporate sector, weak banks, and international credits to 
Korean financial institutions. In Russia in 1998, lack of fiscal 
discipline led ultimately to default on the government's GKO's--
domestic-law debt denominated in domestic currency--as well as 
widespread default by Russian banks on foreign-currency hedge 
contracts. In Brazil in 1998 -1999, doubts arose about fiscal 
sustainability, but default on the sovereign's (mainly domestic-law) 
debt was avoided. In Turkey since early 2001, there have been questions 
about debt sustainability for the government and the banking system; 
but most of the debt in question is domestic-law and/or private. The 
growing volume of official debt of Turkey, mainly to the IMF, would not 
be subject to a SDRM. In Brazil at present, there are worries both 
about fiscal sustainability and about external payments viability; but 
most government debt is domestic, and most external debt is private. In 
Uruguay at present (if this is considered a ``major'' emerging market 
financial crisis), there are concerns about the sustainability of the 
public debt, which is mainly domestic-law debt; as well as with the 
stability of the domestic banking system which has a large volume of 
foreign-currency denominated liabilities. Thus, in all of these cases, 
it is hard to see that if a SDRM had been available it would have done 
much good; certainly it would not have been a magic bullet that would 
have avoided a crisis or substantially diminished its severity.
---------------------------------------------------------------------------
    \9\ In arguing that a SDRM would probably be of limited practical 
use, Edwin Truman, my colleague at the IIE, has emphasized that most of 
the large emerging market financial crises have not involved sovereign 
default of foreign-law debt as a major issue.
---------------------------------------------------------------------------
    Even if a SDRM would do little good in dealing with potential or 
actual emerging market financial crises, if it might occasionally do 
some good, is there reason to oppose it? Might it also do significant 
harm? There is at least some reason to be concerned with this 
possibility. Those who are most directly concerned foreign-law debt of 
emerging market sovereigns--the issuers of such debt, the investors in 
such debt, and the underwriters and brokers of such debt--generally 
oppose a SDRM. The issuers fear that their borrowing costs will go up 
because investor will demand higher rates to compensate for increased 
risks of losses from defaults under a SDRM. Investors object because 
they fear that their rights to recover when a sovereign defaults will 
be compromised and eroded by a SDRM. (Indeed, some are so fearful that 
they have chosen to embrace the more modest proposal of requiring 
collective action clauses in all emerging market debt issues--provided 
that the ``nuclear option'' of a SDRM is abandoned.) The market makers 
fear that the volume and profitability of their business will decline 
under a SDRM. They may well all be right.
    The argument on the other side is that market for foreign-law 
sovereign debt presently benefits from an implicit subsidy that leads 
to too much issuance of such debt, too much investment in such debt, 
and too much dealing in such debt. The implicit subsidy comes from the 
expectation that, if default threatens, the international community 
will step in with large packages of official support that will, to some 
meaningful extent, shield both the borrower and the investor from 
losses to which they otherwise would rightly have been subjected. 
Indeed, the principal supporters of proposals for a SDRM include 
particularly officials from those governments that are the major 
suppliers of the financing in official support packages. Many of these 
officials believe that there are huge problems of moral hazard arising 
from large official support packages, and they see a SDRM as a 
desirable innovation to help cut back on such packages.
    On this controversy, I have a relatively neutral position--both 
sides are wrong. The fears that the market for emerging market 
sovereign debt will be destroyed by a reasonably structured SDRM are 
probably exaggerated. Indeed, it is possible that a well-structured and 
competently implemented SDRM might improve the functioning of the 
market to the mutual benefit of issuers, investors, and dealers. On the 
other hand, concerns about substantial moral hazard arising from 
(properly implemented) international support packages have no 
analytical or factual foundation.\10\ And, as previously discussed, a 
SDRM would have little practical relevance to most emerging market 
financial crisis.
---------------------------------------------------------------------------
    \10\ The assertion that there is a substantial problem of moral 
hazard arising from large international support packages is often 
advanced with great vehemence and conviction (for example, in the 
majority report of the Meltzer Commission), but little evidence or 
rigorous analysis has been presented to back this assertion. Instead, 
like a principle of religious faith, proof is supplied primarily by 
loud and repeated incantation. Those who have analyzed the issue 
carefully generally conclude that this asserted problem of moral 
hazard, while not entirely bogus, has been much exaggerated. See, in 
particular, O. Jeanne and J. Zettelmeyer, ``International Bailouts, 
Moral Hazard, and Conditionality,'' Economic Policy, 33, October 2001, 
pp. 409 -431. I have also examined this issue quite extensively; see 
Mussa, et. al., ``Moderating Fluctuations in Capital Flows to Emerging 
Market Economies, in P. Kenen and A. Swoboda (eds.), Reforming the 
International Monetary and Financial System, International Monetary 
Fund: Washington, DC, 2000, pp. 75-142; M. Mussa, ``Reforming the 
International Financial Architecture: Limiting Moral Hazard and 
Containing Real Hazard'' in D. Gruen and L. Gower (eds.) Capital Blows 
and the International Financial System, Australia: McMillan Publishing 
Group, pp. 216 -236; and M. Mussa, ``Reflections on Moral Hazard and 
Private Sector Involvement in the Resolution of Emerging Market 
Financial Crises,'' paper presented to a conference at the Bank of 
England, July 2002.
---------------------------------------------------------------------------
    What then should be done about a SDRM? For the present, I would 
recommend that it continue to be studied; but for two reasons, I would 
oppose its implementation. First, there is the general conservative 
principle that it is generally unwise to adopt potentially important 
innovations when a clear need for them has not been demonstrated and 
when the possible advantages and disadvantages are not well understood. 
The fact is that a SDRM would have done little to help reduce the 
likelihood or severity of past emerging market financial crises. There 
is no reason to believe that a SDRM is urgently needed now.
    Second, there is what I refer to as the ``Elmer'' principle. Elmer 
was the cat we had when I was a child about 50 years ago. For a feline, 
Elmer had a particularly affectionate and docile disposition--except 
when confronting other male cats, when he exhibited extreme hostility 
and aggression. In dealing with this latter problem, my father wisely 
advised, ``It is usually a mistake to try to referee a cat fight. You 
are likely to be scratched and bitten; and your intervention is 
generally not appreciated by the principal participants.''
    A sovereign default on its foreign-law debt creates a situation 
analogous to an enormous cat fight--only involving batteries of lawyers 
in addition to the primary participants. The interests of the debtor 
conflict with those of creditors as the debtor strives to pay less and 
creditors seek to collect more. The interests of different creditors 
conflict as each attempts to maximize his own return. The interests of 
other claimants on the sovereign resources (including holders of 
domestic-law debt) also come seriously into play; the more they get, 
the less is available for holders of the sovereign's foreign-law debt.
    At present, the international community stands largely aloof from 
the fray, leaving it to the contending parties to work things out as 
best they can.\11\ Under a SDRM, the international community would 
become a referee of the conflict--at least as far as establishing and 
attempting to enforce some general guidelines concerning the resolution 
of differences between the sovereign and holders of its foreign-law 
debt. Rightly or wrongly, the international community is likely to be 
accused by all parties of failing to treat their interests fairly, and 
is likely to be called upon by all parties to use its authority to 
support their particular interests. And even if the international 
community could somehow determine what a ``fair'' resolution was, it 
would probably be unable to enforce it on all relevant parties--perhaps 
especially on the sovereign in default and on some of the domestic 
claimants on the sovereign's resources. It seems to me that the masters 
of the affairs of the international community would want to think long 
and hard before embarking of such a hazardous and probably thankless 
venture.
---------------------------------------------------------------------------
    \11\ The IMF's policy of ``lending into arrears'' does imply modest 
official sector involvement in the resolution of sovereign defaults on 
external debt--just as did the earlier IMF policy of not lending into 
arrears. Under the present policy, the IMF will, in some circumstances, 
lend to a country that is in default on its obligations to private 
external creditors--provided that the sovereign is making reasonable 
efforts to resolve the situation. This policy presumably gives the 
sovereign a little more leverage versus his creditors than did the 
earlier policy of not lending into arrears (which tended to give a 
little more leverage to creditors). The IMF's judgment about what 
constitutes a reasonable effort, however, is not intended to be used to 
influence in any detailed way how disputes between sovereigns and their 
external private creditors are resolved.
---------------------------------------------------------------------------

                 PREPARED STATEMENT OF SCOTT A. OTTEMAN
                 Director of International Trade Policy
                 National Association of Manufacturers
                            October 16, 2002

    I am Scott Otteman, Director of International Trade Policy at the 
National Association of Manufacturers (NAM). The NAM is an organization 
of 14,000 member firms--10,000 of which are small or medium-sized. Our 
members produce the vast bulk of U.S. manufactured goods and are world 
leaders in productivity and product quality.
    I am pleased to be here this morning to discuss the financial and 
economic situation in Latin America and to present the NAM's views on 
how this affects American business, American jobs, and the U.S. 
economy. We can look at the relationship from three perspectives: (1) 
trade--the exports and imports of goods and services; (2) investment--
the direct participation of United States firms in Latin American 
economies; and (3) the effect that financial instability in Latin 
America might have in terms of a spillover to the broader global 
economy. While the first two aspects are of considerable significance, 
it is the third aspect that is probably of the greatest concern to the 
business community.

The United States-Latin American Commercial Relationship
    To begin with, Mr. Chairman, I think it is useful to review the 
size of the United States-Latin American economic relationship. It is 
an important relationship for the U.S. economy, but it is especially 
critical for the Latin American countries' economies. For purposes of 
my testimony, Mr. Chairman, today I am going speak only of the 
countries in South and Central America. Mexico, while sharing language 
and cultural heritage with the rest of Latin America, over the past 10 
years has been integrating its economy with North America through the 
North American Free Trade Agreement (NAFTA). As a result, Mexico's 
economy is increasingly insulated from economic winds that may affect 
Central and South America.
    United States exports to Central and South America last year were 
almost $60 billion, about 8 percent of United States exports to the 
world. Imports from the region were $67 billion last year, about 6 
percent of our global imports.
    Fully 88 percent of our exports to Central and South America are 
concentrated in manufactured goods, including computers, aircraft, 
turbines, plastics, and a broad range of machinery and electrical 
machinery. Petroleum is our largest import from the region, accounting 
for about one-third of the total. Apparel is our second largest import 
from Central and South America, followed by a range of manufactured 
goods, agricultural products, and raw materials. Our imports are 
changing in the direction of more manufactured goods, as is seen in the 
fact that our largest imports from Brazil have become commercial jet 
aircraft and electrical machinery.
    United States foreign direct investment in South America, both 
overall and in manufacturing, is about 6 percent of worldwide United 
States direct investment. In 2001, the value of United States 
investments in South America stood at $83 billion, with $36 billion 
invested in Brazil and $18 billion in Argentina--the two largest South 
American recipients of United States direct investment.

The Effect of Financial Instability
    Argentina's economic and political crisis and its limited spillover 
effects to its neighbors have immediately affected United States 
companies in two ways--via a dramatic decline in United States exports 
to South America and by substantially worsening the conditions for 
doing business faced by United States firms operating in the region. 
Among the companies based in the region, clearly the hardest hit are 
those based in Argentina itself, though there are trade effects that 
have also impacted the business environment in neighboring countries.

Exports
    United States exports to Central and South America so far this year 
have fallen 16 percent from the same period a year ago. The three 
largest proportional declines were to Argentina, Uruguay, and Brazil. 
Table 1, attached to my statement, shows the changes in United States 
exports to all countries in the region.
    United States exports to Argentina have plummeted a stunning 67 
percent--dropping from an annual rate of $4.5 billion to $1.5 billion--
a $3 billion fall. Exports to Argentina face a triple-whammy: (1) very 
low demand due to 4 years of recession/depression in that country; (2) 
a huge competitive disadvantage due to the 70 percent devaluation of 
the Argentine peso, which makes foreign imports much more expensive 
than similar domestic goods; and (3) foreign-exchange curbs imposed by 
Argentine authorities to improve the country's current account balance.
    Exports to Uruguay have fallen 53 percent, though because Uruguay 
is a much smaller market, the dollar decline was only $240 million. 
United States exports to Brazil have dropped 26 percent, from an annual 
rate of $16.5 billion to $12.2 billion--a $4.3 billion fall.
    As a rough rule of thumb, the Commerce Department estimates each $1 
billion of exports supports approximately 12,500 jobs. This implies 
that the export losses over the last year to Argentina, Brazil, and 
Uruguay may have impacted possibly over 90,000 American jobs.
    The declines in United States exports to Argentina and Brazil are 
in line with the decline in these countries' overall imports from the 
world. For example, Argentina's global imports so far this year have 
fallen 63 percent--meaning they are only about one-third as large as 
they were last year. Brazil's total imports have fallen about 23 
percent.

Investment/In-Country Operations
    U.S. investment in the economies of these countries has been 
sharply affected as well. United States balance of payments data show, 
in fact, declining investments to South America, concentrated in 
Argentina and Brazil. Income on United States investments has 
plummeted. United States foreign direct investments in Argentina have 
lost $2 billion in the last 9 months.
    Logically, those United States businesses with operations in 
Argentina are the ones that have been most severely impacted by that 
country's financial crisis. In responding to the crisis, the Argentine 
government has forced the conversion of dollar-denominated payments to 
local currency-denominated payments at a one to one ratio, when the 
real market exchange rate is closer to one to four (so-called 
``pesification''). This step alone has slashed the anticipated income 
stream of U.S. subsidiaries invested locally by 75 percent and made 
severely undermined the value of many of the underlying assets. At the 
same time, efforts to recoup these losses by seeking higher prices or 
charging higher rates for services have been in many cases forbidden, 
putting many companies--foreign and domestic--in an untenable position 
and causing many local bankruptcies.
    Non-payment of contracts is perhaps the biggest fallout from the 
crisis for those on the ground in Argentina; it has sapped business 
confidence and resulted in suppliers demanding upfront payment rather 
than accepting credit. United States firms in Argentina are finding 
that even peso-denominated debts are often not being paid by bankrupt 
or near-bankrupt customers.
    United States subsidiaries have been undermined further by a series 
of measures the Argentine government or legislature has taken to 
attempt to preserve foreign exchange reserves. This includes the 
institution of an export tax on a nearly across-the-board basis. For 
companies that are export-focused, as are many United States operations 
in Argentina, this new tax partially or wholly undermines the renewed 
competitiveness won at the altar of the devalued peso. Needless to say, 
this new tax, imposed as a last resort to raise hard currency, comes at 
a time of tremendous weakness for most firms.
    In addition, the crisis has led the government to impose import 
controls, limiting the expenditure of dollars on critical inputs needed 
to sustain or augment production. For example, some U.S. agribusiness 
firms--which otherwise have good prospects for renewed growth because 
of the devaluation-related potential for increased exports--find their 
ability to take full advantage to be hampered by a lack of access to 
key inputs, such as seed, fertilizer, and farm equipment.
    Furthermore, even companies with dollar reserves are missing debt 
payments denominated in dollars because the Ministry of the Economy 
must grant permission for such transactions.
    Add to these costly measures the understandable worker 
disgruntlement and the heightened kidnapping and security threats faced 
by business executives and their families as a result of the drop-off 
of more than half the Argentine population below the poverty line, and 
you see that United States companies--along with others--face a very 
challenging business environment in Argentina today.

Intraregional Trade
    Argentina's problems have also affected United States companies' 
operations in neighboring countries, though clearly to a lesser extent 
than those based in Argentina itself. The impact has occurred primarily 
because of lost trade due to the collapse of sales to Argentina, which 
had been a significant portion of sales for many export-focused 
companies in an increasingly integrated South America.
    A broader ``contagion'' effect--with severe pressure on the 
domestic currency and the banking system, as foreign and domestic 
investors rush for the exits--has also been seen in Uruguay. But in the 
case of Brazil, our understanding is that most financial experts 
attribute the recent pressure on the Brazilian currency to uncertainty 
surrounding the outcome of Brazil's current presidential elections and 
the new government's possible economic team and policies rather than to 
fallout from Argentina.
    The United Nations' Economic Commission for Latin America and the 
Caribbean (ECLAC) has done some estimates of the decline in 
intraregional trade in South America due to Argentina's economic 
problems. ECLAC says Argentina's imports from its neighbors are 
expected to tumble from $6.5 billion in 2001 to $2.2 billion this year. 
Uruguay has been hit the hardest, with its goods exports to Argentina 
falling 70 percent in the first 4 months of 2002 compared to the same 
period in 2001. Brazil has also seen its merchandise exports to 
Argentina slide dramatically. Argentina accounted for 11 percent of 
Brazil's exports in 2000, but now only account for 4 percent. The 62 
percent decline in Brazil's exports to Argentina so far this year is 
equivalent to an overall decline of 7 percent in Brazil's total 
exports. United States companies' Brazilian and Uruguayan operations 
are among the firms suffering from these trends.

Political Impact
    Perhaps the longer-term danger for United States business and for 
the interests of Latin America and the United States in the Western 
Hemisphere is the emerging perception among the people and politicians 
of the region that financial crisis and 
economic stagnation are somehow caused by free-market reforms. Over the 
past 15 years, newly democratic Latin American governments made 
tremendous strides in opening their highly regulated, over-protected 
economies--controlling inflation, attracting foreign investment, 
privatizing state enterprises, and lowering trade barriers. Until 1997, 
these reforms yielded substantial though uneven growth. It seemed only 
a matter of time before the open-market policies known as the 
``Washington Consensus'' would deliver on the promise of broader 
prosperity across the region. Over the last few years, however, growth 
has slowed, and recurring financial instability has continued to be a 
major problem. Increasingly, leading actors on the Latin American 
political scene are raising questions about the free-market model's 
ability to provide sustainable economic growth and development.
    The collapse of Argentina, whose governments in the 1990's were 
viewed throughout Latin America as among the most aggressive 
implementers of open market 
reforms, threatens to further inflame protectionism and antireform 
sentiments in the Americas. Attributing Argentina's current predicament 
to ``outside forces'' or globalization per se may be a popular way to 
win votes, but it cannot restore confidence or form the basis for a 
reactivation program that allows one to actually 
govern and deliver sustainable results to society.
    In our view, any attempt to turn back the clock by returning to 
policies aimed at substituting inefficient domestic production for 
competitive imports or rolling back other reforms would be a costly and 
disastrous mistake. Although some of the reforms of the late 1980's and 
1990's could have been carried out more gracefully--perhaps at a 
different pace, or in a different sequence--the main problem is that 
the reform process has not advanced deeply enough. Rather than return 
to the past, Latin America needs to continue opening its economy to 
trade and investment. The so-called ``first generation'' reforms I 
mentioned earlier need to be complemented with ``second generation'' 
reforms that promote respect for the rule of law (judicial reform), tax 
reform, labor market mobility, limits on government spending, 
educational reform, and sensible regulatory regimes. No amount of 
populist rhetoric can alter this reality.

An Even Bigger Concern: Brazil's Future Policies
    If financial collapse were to spread to Brazil--either because of 
contagion from Argentina, uncertainty provoked by the new Brazilian 
government's economic and 
financial policies, or some combination--the potential negative impact 
on United States business would be vastly enlarged. Some 400 of the 
United States Fortune 500 companies have operations in Brazil, which 
continues to be South America's most dynamic economy and the eighth 
largest economy in the world. A Brazilian financial disaster such as 
Argentina would not only undercut the operations of United States firms 
invested and trading in Brazil, it could spread investor panic and 
depress growth prospects throughout Latin America and perhaps the rest 
of the developing world, similar to what we saw initially with Mexico 
in 1994 and with Asia in 1997. I want to underscore that, in my 
opinion, we are far from this scenario, which is one that certainly can 
and must be avoided.
    U.S. policy and the international financial community have 
important roles to play in avoiding this type of disaster. I will leave 
it to the financial experts to make recommendations to the U.S. 
Government and international financial institutions. However, the 
experience of NAM member companies as international traders and 
investors leads us to believe that the most critical role in avoiding 
such a crisis inevitably falls to the Brazilians themselves. Regardless 
of who wins the October 27 run-off, the new Brazilian President can do 
much to allay (or enhance) the uncertainties found in financial and 
business circles today. Here are a few suggestions:

 Appoint an experienced economic team that understands 
    international finance and recognizes the importance to Brazil's 
    future of deeper and broader integration into the world economy.
 Make clear that the new Brazilian government will honor its 
    international debt and other obligations.
 Reaffirm Brazil's commitment to successfully negotiating a 
    Free Trade Area of the Americas by no later than 2005, as President 
    Cardoso pledged, along with 33 other Western Hemisphere leaders, in 
    1994.
 Take the lead among Latin American nations in insisting that 
    the FTAA include chapters or provisions that fully protect foreign 
    investors, fully respect and 
    enforce intellectual property rights, expedite shipments through 
    customs, and guarantee transparent, nondiscriminatory competition 
    for government contracts. (Naturally, Brazil should seek to 
    negotiate an FTAA agreement that is strongly in its interest, just 
    as United States officials are doing to promote the achievement of 
    United States interests. But the important thing is that the 
    incoming Brazilian authorities make it plain that, contrary to 
    their campaign rhetoric, they recognize the FTAA is essential for 
    Brazil's future.)

    In the cases of Argentina, Uruguay, and Brazil, one of the most 
important things that must be restored is confidence. Investors, both 
local and foreign, must become confident that government officials and 
international institutions can stabilize the situation and ensure the 
preconditions for resumption of growth. Local residents will not bring 
their savings back to their countries and foreign investors will not 
resume investing until they believe their capital will be safe.

Looking to the Future
    Once the immediate threat of financial crisis is overcome, there 
are additional steps that must be taken to achieve the stable, 
democratic, and prosperous Western Hemisphere that should be the 
ultimate objective of U.S. foreign policy. In particular, I would call 
your attention to the need to advance several initiatives that aim to 
bring about a stronger rules-based system with improved adherence to 
the rule of law and to practices of good governance.
    The most important step would be for Latin American governments, 
including Brazil as I mentioned earlier, to reiterate their support for 
the Free Trade Area of the Americas (FTAA) negotiations and urge that 
the agreement be concluded as quickly as possible. Prior to the United 
States Congress' approval of Trade Promotion Authority earlier this 
session, Latin American and Caribbean governments could legitimately 
question the United States' commitment to completing the FTAA. That is 
no longer the case, and with the United States prepared to issue its 
initial FTAA market access offers as early as this December, the ball 
is now in the Latin Americans' court. A clear signal from governments 
throughout the region that they want to negotiate seriously and 
expeditiously would have a strong positive impact on investors, for 
embracing the FTAA means that governments intend to face the future 
with a better and more transparent set of rules that will govern not 
just trade, but also investment and commercial practices. And more than 
anything else, embracing the FTAA demonstrates that governments intend 
their countries to be open markets--open internally and open to trade.
    In this regard, it is instructive to recall the experience of 
Mexico in its two economic crises of the early 1980's and the mid-
1990's. In the 1982 debt crisis, Mexico nationalized its banking 
system, curbed imports, and took other steps that scared off domestic 
and international investors. As a result, Mexico was not able to regain 
access to international financial markets for 7 years, and it suffered 
through the so-called ``lost decade'' of stagnant growth and deepened 
poverty. But in the 1994 peso crisis, Mexico was constrained by its 
membership in the General Agreement on Tariffs & Trade (now the WTO) 
and the NAFTA agreement from adopting similar antimarket, populist 
measures. After some initial financial miscalculations, Mexico took 
remedial measures in 1994 and 1995 that were market-sensitive and gave 
investors confidence in the economy. Though a deep downturn resulted, 
its length was limited, and a catastrophe was averted. Mexico regained 
access to international financing in just 7 months.
    Today, as we approach NAFTA's tenth anniversary, investors have 
many fewer fears about Mexico's future. Even though Mexico is suffering 
a mild economic downturn linked to its relative dependence on the soft 
United States market, investors remain confident because of its NAFTA 
obligations and because of the economic and political reforms that have 
been carried out during the NAFTA years. The same can happen in South 
American countries, where, in many instances, similar levels of 
confidence are now absent.
    Chile's experience is also instructive. Chile is arguably the most 
open economy in South America. Its economic and trade reforms have led 
to the most rapid rate of economic growth in the continent and to an 
extremely high degree of investor confidence. This confidence is one of 
the reasons that Chile received an astonishing 70 percent of all new 
United States foreign direct investment directed toward South America 
last year.
    Additionally, the Inter-American Convention Against Corruption 
should be rigorously implemented by all countries in the Western 
Hemisphere. The United States has long been a leader in the fight 
against corruption in world markets, starting with the Foreign Corrupt 
Practices Act of 1977. I recognize that the scandals of the past year 
demonstrate that no nation has its hands completely clean when it comes 
to corporate corruption. But the United States nonetheless has led, and 
must continue to lead, this fight throughout the hemisphere, because 
bribery distorts economies and corruption eradicates faith in governments 
and economic systems. Corruption undermines social values and democracy, 
and leads to massive diversion of scarce economic resources away from 
intended purposes. It retards economic growth and discourages foreign 
investment. Adherence to the convention, and the establishment of 
transparency measures for government procurement, would do much to help 
reestablish the confidence that domestic and foreign investors need.

Conclusion
    Along with local businesses and companies around the world that do 
business with South America, United States firms are clearly being 
impacted by the economic downturn in South America. This includes both 
United States exports to the region and United States company 
production and other business operations in South America. As is 
evident in the available data, as well as in the anecdotal information, 
the effect is very marked--especially with respect to Argentina.
    U.S. businesses and their employees, of course, want to see a 
restoration of stability and a return to economic growth just as 
quickly as possible. American firms are good corporate citizens of the 
countries in which they operate, and are concerned not just for their 
own operations but also for the conditions facing the people in those 
countries. The economic catastrophe in Argentina has brought with it a 
particularly tragic cost in terms of people's lives and their 
aspirations for the future.
    It is our sincere hope that the U.S. Government, the international 
financial institutions, and other governments in the Western Hemisphere 
can learn from the lessons of the past and work together to promote 
policies that not only avoid repeating such tragedies in the future, 
but also lay the groundwork for broadening prosperity throughout the 
Americas.
    Thank you.
    
    
