Milei's Psycho Shock Therapy

My short piece for Dollars & Sense on Milei's economic program is out now, here. An early version is available here. Btw, this is the 50th anniversary issue. By coincidence, 20 years ago, a piece of mine on Brazil (and the Lula government back then) was also published on Dissent on their 50th anniversary issue.

The Milei piece was written in June and revised around September. Now it seems more clear that they might receive some fresh money from the IMF, which will allow them to continue to pushing the adjustment well into next year, and, perhaps beyond. Note that this is exactly what the same team during the Macri administration. Try to cut spending in domestic currency (now more drastically) and, hence, debt in pesos, and increasing indebtedness in dollars. The money will probably come in, and as the interest rate differential remains negative, it will probably not lead to the accumulation of reserves. To be seen.

Dollarization in Argentina?

So I have no insider knowledge on what the Argentinean government plans to do. And the White House is a mess; they don't have any knowledge on what they plan to do. But Larry Kudlow, the Director of the National Economic Council, said that the Treasury is deeply involved in a plan to dollarize the Argentinean economy (Guillermo Calvo, an influential conservative economist, has also spoken in favor of dollarization; see here in Spanish).

He supports a Currency Board to solve the run on the currency, and the long-term external problems. That worked well in the 1990s, he said, without a hint of irony. The notion is that the problem, again difficult to believe this type of stuff is still around, is a fiscal problem. So, no fiscal deficits, no printing of money, no inflation, and no depreciation of the currency as the proportion of pesos to dollars increases. The logic of full employment (neoclassical theory), monetarism (Quantity Theory of Money), and a version of Purchasing Power Parity for the determination of exchange rates. It is all very simplistic.

Of course Macri's government promised to do a fiscal adjustment, and to block the central bank to lend to the treasury. But the real problem is external. There is a long-run problem of sustainability of the current account (as I noted earlier). But the real problem now, in the short-run, is the lack of reserves and the forthcoming obligations in dollars (not in pesos). My take on currency crises as being related to external problems here (and the paper here; note that this is about the long-term or fundamental causes, not necessarily the short-run crisis like the one in course now).

I should also say that the fiscal problems that exist have been caused by the government, and not only have nothing to do with the external crisis, they are instrumental, in some sense, in promoting the austerity cuts that allow for the reduction in social spending. As I noted even before the Macri governments started in 2015 (when I wrote it, but published in January 2016)*:

"the coming larger fiscal deficits will most likely be used to try to cut social welfare expenditures, which increased significantly during the administration of the outgoing president Cristina Fernández and her predecessor (and husband) Néstor Kirchner. It would not be surprising if Macri tries to privatize social security once again, something that Menem accomplished in the 1990s, and which had to be reversed in the 2000s as a result of the private system’s complete failure to provide a decent retirement for seniors."

And that is essentially what dollarization would be there to do. Tie the government's hands and help promote an even more brutal fiscal adjustment than the one the IMF (that, yes, has changed a lot, has it not?) can help impose. Why go to the US Treasury, you ask; because it can provide enough dollars to guarantee the stabilization of the currency, and perhaps some lower inflation (by stoping the pass-through to domestic prices), giving Macri or a right wing candidate a fighting chance next year in the presidential elections.

However, dollarization would not solve the long-term current account problems, it will intensify them in fact, and a new collapse like the one from 2001-02 would be inevitable. Argentinean elites, you might think, keep committing the same mistake over and over again. But there again, from their perspective this is fine. The crisis only hits the poor (and the middle classes that are still somehow afraid about the devil of populism). Macri complains about the Kirchner legacy (three years into his government), but dollarization would be truly a terrible legacy. Oh well.

PS: The government has denied plans to dollarize. There again he said in 2015 he would not devalue the currency.

* I also predicted the contraction and the devaluation, which Macri firmly denied back then.

What is the Central Bank of Argentina Actually Doing?

Brief note in Spanish (no translation, sorry) on the long history of central banks and the current policies of the Argentinean central bank (BCRA). The gist of the argument is that while central banks where created to finance developmental states in the nascent merchant capitalist societies, in the periphery they tended to follow the Victorian model (implemented later) emphasizing inflation control as the main official goal. However, often, as in the recent case of the BCRA, they are used to accelerate inflation and fuel speculation, if that allows for lower real wages, which was Macri's administration not so hidden goal (from an old, but revealing interview).

From Vulture Funds to 100-year bonds: Has Argentina Turned Around?

Just a couple of years ago Argentina’s left of center government was besieged by foreign investors, the hedge funds known as Vulture Funds, that demanded full payment for their bonds acquired at heavily discounted prices in the secondary markets. The New York courts ruled in favor of the Vulture Funds, and Argentina was unable to borrow in international markets, even though during the successive governments of the late Néstor Kirchner and her wife Cristina Fernández de Kirchner the country had successfully renegotiated its debts with 93 percent of the bondholders, and the economy had recovered from the worst crisis in its history, growing at fast pace while diminishing inequality.

In November 2015, the left of center candidate associated to the Kirchners lost a close election to the center-right, neoliberal ex-mayor of Buenos Aires. Mauricio Macri, the new president, the heir to a private fortune amassed mostly during the last and bloody dictatorship and the ex-president of Boca Juniors, the most popular football team in Argentina, had promised reforms to reignite growth, that stalled in the last few years of Cristina Fernández’s administration, alongside with the slowdown of the global economy, and a collapse of the prices of commodities like soybeans, Argentina’s main export resource.

Macri’s administration devalued the peso, even though he had promised he would not do it during the campaign, promoted fiscal adjustment, eliminated export taxes that had been imposed by the Kirchners that affected the wealthy, and agribusiness interests in the country, and increased tariffs of public services, that were seen as distorting the functioning of markets. These market-friendly policies, were seen as the basis not only of a renewed process of growth, but also the fundamentals for establishing price stability. Yet, the economy stagnated and inflation run out of control.

The reasons are simple. A devaluation is generally both contractionary and inflationary, since a devaluation increases the prices of imported goods, directly affecting prices, and also, by increasing the cost of living it leads to a reduction in real wages. Lower wages, in turn, translate into lower consumption, and reduce demand, which leads to a recession. The increases in tariffs deepened the inflationary pressures, while the recession, which implies lower income and a reduction in tax revenue, together with the reduction in export taxes, lead to a worsening of the fiscal accounts. All of that was expected, including by Macri’s government. In fact, higher inflation that reduced real wages, and higher unemployment that weakened trade unions were central to the economic plans of Macri’s administration, as much as renegotiation with the Vulture Funds and reentrance into international financial markets. The US$ 2.75 billion 100-year bond issue is the crowing of these efforts.

The Argentinean bonds will pay around 8 percent per year in dollars for the next hundred years. One may reasonably ask why international financial markets would lend to Argentina, a country that has defaulted between four and seven times before, depending on who you ask. According to the Financial Times it is all a response to the smooth-talking telegenic new president and his market friendly reforms, even though Macri, very much like George W. Bush, was born with a silver foot in his mouth, and the reforms have backfired. In reality the reason for the renewed lending, is that, in spite of its several defaults, the country is a good payer. The very high interest rate implies that even if Argentina eventually defaults, a bondholder can make quite a lot of money. And there is always a chance of selling the bonds in the secondary markets, after making enough back with the high interest rates. Remember that interest rates have been close to zero in international markets, and sometimes negative in real terms, since the last global meltdown in 2008. On top of that, Vulture Funds can always make a buck if Argentina defaults again in the next hundred years. That is their business model.

The question you should really ask is why Argentina would borrow again and continue the long cycle of borrowing and defaults. Macri’s development strategy is a throwback to the Washington Consensus of the 1990s. In other words, the Macri administration is pushing for free trade, financial deregulation and a reduced role for the State at home, when these policies have been under attack and in retreat around the globe, more prominently in recent times with Brexit and the election of Donald Trump in the United States. The hope is that increased integration to world markets would bring investment and lead to growth, and that growth in the long run would make it viable for Argentina to repay its debt. The risks are evident.

It is unlikely, if not impossible, to think that foreign investment will come and promote growth. The narrow specialization of the Argentinean economy on commodities makes it vulnerable to recurrent crises when prices of its exports collapse. Also, the borrowing in dollars implies that only exports can provide the necessary resources for repaying the increasing foreign debt. This story cannot, and probably will not, end well. The only reason to promote this increase in foreign indebtedness is the short run gain associated to the higher interest rates that these 100-year bonds pay. Not only foreigners, and foreign pension funds will buy these bonds, but also Argentineans. For those that are wealthy enough to hold dollar denominated bonds in their portfolios the very high interest rates, even if risky, imply that Argentinean bonds are a good deal, an oasis of high remuneration in the midst of a financial desert.

It is worth remembering, in this context, that it is estimated that wealthy Argentineans hold assets abroad for about the total value of the country’s foreign debt. Macri and his friend are certainly among those that would benefit from his own policies. Also, one should not forget that Macri’s name appears in the Panama Papers, and contrary to what happened in other countries that had politicians implicated, he did not resign after the revelation that he illegally funneled funds to a tax haven. The 100-year bonds are not a sign that the economy is finally doing well, but a brief respite before the coming storm.

More on the Argentine adjustment

I'll post a longer discussion later, but I wanted to provide a short update on the situation in Argentina. Everything indicates, as I had noted before, that the government of Macri wanted to accelerate inflation, with depreciation and an increase in the electricity bill.Macri rehired the technician (Graciela Bevacqua) that had been fired by Cristina Kirchner, and that led to the (mostly true) critique that inflation was higher than the official measure indicated.  More importantly, for a government that constantly bashed the previous administration for lying about inflation, they fired the same technician as soon as it became obvious that inflation was accelerating (you can check the numbers in Cavallo's website; this is the son, not the infamous finance minister; as it can be seen inflation accelerates again in November 2015, right after the election, with the huge depreciation of the peso).

Also, it is clear that the economy is slowing down, with the index of production provided by Ferreres suggesting a fall in January of about 1.1%. Not clear what the new unemployment rate is, but the increase in the layoffs in the public sector, and lower growth will lead to higher unemployment. It is true that given the current account problems the economy had already slowed down in the last 3 years or so, but the adjustment and the depreciation will likely throw the economy in a recession (we will see if the hopes of the Argentine new developmentalists pan out, and export-led growth compensates the collapse of the domestic market; I, obviously, doubt it).

Finally, Argentina is also finalizing an agreement with the Vulture Funds, which basically accepts all their demands. Regularizing the situation and having access to international financial markets is not a bad idea, but certainly there was no reason to cave to the Vultures' demands. So more inflation, to reduce real wages, and lower growth, also to weaken the labor force's bargaining power and roll back the social progress of the last decade or so. And that's why Macri was elected anyway.

PS: There are many other problematic issues in this very short administration so far, including the packing of the court, and the treatment of human rights organizations, to name a few. But it seems that in general I more or less got it right in my talk on what to expect in November, and the article that followed.