The danger of borrowing

President Bush is trying to boost the economy

		Rodney Smith BBC business reporter

"Let's spend $100bn to reinvigorate the economy," said President George W Bush - although Congress still has to agree with him.

"Let's throw taxpayers' money at the National Health Service" says British Chancellor of the Exchequer Gordon Brown.

Not quite like that, but he is expecting an increase in state spending from surplus this year to a £12bn deficit next year.

Two powerful political figures who have decided to cope with national economic problems by digging into the national bank account. They will be borrowing money.

Rough Justice?

The US economy was already slowing fast, and the US deficit shrinking, before the attacks of 11 September.

On that day, an opinion poll by ABC News and the Washington Post showed that a majority of Americans said they would be prepared to forgo President Bush's planned tax cut if it would help the dwindling budget surplus.

But the US and UK spending plans are exactly the sort of medicine that governments like the US and Britain criticise other countries with problems, like Argentina, and Turkey, for employing.

Struggling developing countries are told to cut their deficits by cutting spending, and raising money through higher taxes.

Can this be just? Sadly yes, but these cases do not compare like with like.

Risking default

Britain, the US, indeed the developing countries have not reneged on debt repayments in living memory (apart in some respects from Britain's infamous War Loan).

Argentina and other struggling economies have, Turkey could do so.

Yet the formulae proposed by the International Monetary Fund (IMF) have been attacked from within the Funds own ranks for sometimes being too tough.

One result has been the recent proposal by a Fund deputy managing director that it develop a sort of bankruptcy protection for sovereign countries; a version of the US Chapter Eleven protection that allows companies shelter from creditors while it attempts to sort out its finances.

Enron exposure

An example of how this works is US energy supplier Enron, which has used bankruptcy protection to find an extra $1.5bn in working capital while it attempts to restructure.

However, in Enron's case, its bankers know the quality of the management, which they can effectively replace if needs be.

They have no such leverage in the case of sovereign debtors.

IMF intentions

Some critics of the IMF's plan say it is only a reworking of what the IMF does already, when it sends a team into a troubled country to advise a government what to do.

Others say the Fund should be less demanding.

But the Fund does not have the reserves to be banker of last resort to all.

It needs the support of other governments, which can be hard-headed, and the big commercial banks, and they are answerable to shareholders.

Shareholders, your and my pension fund, insurance company, maybe bank where we keep our money, would not please us if they backed unsafe ventures.

Turkish woe

So what will happen to countries like Turkey, Argentina?

In spite of warm words of confidence in Turkey by the IMF's director concerned, Michael Deppler, recently, bankers believe Turkey may have to default.

They estimate that sorting out the Turkish banking system alone could cost another $40bn in public debt, that's about 25% of Turkish national income, on top of debt amounting to about 60% of output.

The figures are staggering, in spite of Mr Deppler's assurances that conditions are improving.

Argentine nightmare

The worst nightmare of Argentina's highly regarded economics minister Domingo Cavallo is a return to hyper-inflation and a consequent ruined economy.

He has battled against this for three years, standing with his back to the currency board that pegs the peso to the dollar (and the euro).

But hardened emerging market investors and bankers say Argentina has already de facto defaulted on its $130bn odd of debt by swapping $60bn from high yielding bonds to lower yielding paper.

The government wants to abandon the peso and adopt the US dollar.

That would require a peso-earning economy suddenly to move in step with the dollar-earning US economy.

The strain would be enormous.

The alternative would be devaluation.

Or a cocktail of the two as suggested by HSBC emerging markets economist David Lubin.

Devaluation?

Much of Argentina's debt is denominated in dollars. James Morgan at the Centre for Economic Policy Research says that if the peso were devalued, that debt would almost instantly become unpayable.

The effect would economic disaster.

But those who believe that the market does rule expect devaluation to happen in Argentina, and in Turkey.

The reason is that that is what has happened , eventually, time and again in these circumstances in the past.

Governments strive to support a currency against capital fleeing the failing economy, and eventually are forced to give up, the exchange rate falls, inflation is stoked up.

Devaluation and subsequent inflation wash the slate clean - and the cycle starts all over again.

Malaysian exception

There is one modern exception; during the Asian crisis that began in 1997, Malaysia introduced against all advice exchange controls to keep capital from fleeing.

Against all advice and all modern economic rules, it worked

But that is the exception.

Malaysia was not as severely hampered by international debt as others, like Argentina and Turkey.

So maybe the wisest thing the IMF and the various advisers to both governments could do to stop trying to stem the inevitable flood, would be to plan for the mopping up operation.

A new vision, and an inventive policy there could be the way to deal with future such disasters - and meet another criticism levelled at the IMF - that it prescribes the medicine too late, when splints and bandages are needed.