Back to 19th century, thanks to Argentina 
By HAROLD JAMES 

PRESIDENT Nestor Kirchner of Argentina is often portrayed as an anti-capitalist radical for 
proposing a 'haircut' of more than 90 per cent on the value of Argentina's defaulted external 
debt. But whatever his motives, the anxiety that led up to Argentina's last-minute deal with the 
International Monetary Fund (IMF) to repay US$3.1 billion (S$5.2 billion) owed to the global 
lender may serve to help rescue what capitalism is really about: the appropriate judgment of 
risk. 

Economic development involves financial flows and the build-up of debt. In a domestic setting, 
bankruptcy and default are common. Indeed, one characteristic sign of economic vitality is the 
frequency of bankruptcy, for business failures indicate a willingness to gamble and take risks 
on innovation. 

But in the history of international finance over the past 60 years, bankruptcy and default are 
almost unheard of. One consequence is international markets are not as dynamic as they might be, 
and prosperity not as widespread. 

In the 19th century and in the inter-war and depression years of the 20th century, international 
default came in buckets. Borrowing countries such as Argentina or the Ottoman empire regularly 
defaulted. They were then punished for a few years by not having access to international capital 
markets. Lenders to defaulting countries were also punished, as their instruments, mostly bonds, 
became worthless. The market thus punished bad risk. 

In some cases, as in the Ottoman empire or Egypt, creditors restructured finances by force or 
the threat of it. But gunboat diplomacy was not necessarily part of the resolution of debt 
problems. Argentina, for example, reached a voluntarily negotiated agreement in 1893. 

Such a system worked as long as events in one country did not have a negative impact on other 
borrowers and there was no systemic risk or contagion. When Argentina defaulted in the 1890s, 
European investors simply discovered a new fashion: investment in Russia. After Russia's crisis 
of 1901, investors turned to America and Australia. 

The Great Depression of the late 1920s and early 1930s put an end to such behaviour, which was 
suitable for a moderately crisis-prone world. Crises were no longer moderate. The defaults of 
that time swept across the globe in a contagious panic, destroying financial systems in lending 
as well as borrowing countries. Politicians reacted by devising an international system after 
World War II in which default and bankruptcy were more or less impossible. 

As there were no substantial capital flows for a long time, this did not matter at first. Then, 
in the 1970s, capital flows started up again, and again there were threats to the stability of 
the system. 

Latin America suffered a big debt crisis in 1982; but, in fact, there were almost no defaults 
(with the exception of Peru and Brazil). Instead of defaulting, countries arranged rescue 
packages with the IMF. Money from the international financial institutions was complemented by 
new money that creditor banks were supposed to put up as part of the price of being 'rescued' by 
the IMF. The IMF was given a privileged legal position, and only devastated and wrecked 'failed 
states' such as Sudan would default on loans from it. 

The notion of 'concerted lending' was applied in the big Mexican crisis of 1994-1995 and in the 
East Asian crisis of 1997-1998. The whole point of crisis management was to avoid risks to the 
system and thus bankruptcy. 

But in the second half of the 1990s, this system began to unravel. The sums required from the 
international financial institutions were so large that it began to be possible for currency 
speculators to envisage circumstances in which there would be no help. Private-sector lending 
became hard to mobilise, because there were many more creditors than in the bank-dominated world 
of the 1980s, when negotiations could be conducted by just a few big players. 

The first major shock came with Russia's default and devaluation of August 1998. After that, IMF 
began to encourage some nations to renegotiate debt rather than seek new money, at least if they 
were relatively small-scale borrowers, such as Ukraine or Pakistan, and thus could not endanger 
the whole system. 

The second major shock was Argentina's currency collapse of 2002-2003, after which Argentina's 
government demanded a huge debt write-off. Argentina's other threat, not to repay the IMF, 
challenged the old system just as profoundly and seemed to some a justified response to years of 
bad policy advice from the G-7 countries and IMF. 

In the 21st century, we are returning to the ways of the 19th century. Our aim should be to 
invent financial mechanisms for segmenting and spreading risk, so that one bad case no longer 
has the potential to destroy the whole system. By being less concerned with preventing default, 
we can make risk and reward more congruent with each other. Creditors in cases like that of 
Argentina need to be made to pay a penalty.

Argentina's current actions may drive us back to the 19th century more quickly than some 
investors would like, but that lost world was a world of unquestioned dynamism and growth. 

The writer is professor of history at Princeton University and author of The End Of 
Globalisation: Lessons From The Great Depression. Copyright: Project Syndicate