Hope for Argentina

Four months ago I proposed "A simple fix for Argentina's peso." Late last month, after some much-needed changes in leadership, the central bank announced an agreement with the IMF in which they proposed to do exactly as I recommended: sharply curtail future money printing. In fact, the central bank vowed to deliver zero growth in the money supply over the next year. Wow. Milton Friedman would be jumping for joy.

I'm happy to report that the central bank appears to be honoring its pledge. Over the past four weeks, year over year growth in Argentina's M2 money supply has plunged from 32% to 19%, which corresponds to a 10% outright decline in M2 over a 3-week period. Not surprisingly, this impressive resolve has translated into an almost 13% gain in the peso's value vis a vis the dollar. (Boosting short-term interest rates to 73% certainly helped in this regard, by stimulating demand for pesos.)

In dollar terms, the value of the Argentine stock market has plunged 57% since its January '18 high, but it has been relatively stable for the past two months. The economy is in recession, and discontent with the Macri administration is rampant. There's no assurance things will hold together for another 11 months. How will the government borrow what is needed to fund its deficit (3-4% of GDP) if it can't ask the central bank for free money? Only time will tell. But if the central bank can maintain its resolve for a few more months, a surge of confidence could produce a wave of foreign capital inflows more than sufficient to do the job. There is hope.

Chart #1

Chart #1 shows the level of Argentina's foreign exchange reserves. They surged by almost $30 billion following the late-2015 election of President Mauricio Macri, and were further boosted by about $8 billion thanks to the successful sale of bonds earlier this year. But beginning last April, the central proceded to squander some $30 billion (including monies received as the result of an IMF loan), in a futile attempt to "defend" the peso against massive capital outflows that were sparked by a terribly foolish tax on foreign capital (see the post linked above for more detail). In reality, the central bank simply accommodated capital flight, since the supply of pesos continued to surge. (In technical terms this is called "sterilized intervention.") Very foolish.

Chart #2 

Chart #2 shows the level of Argentina's M2 money supply, which grew at a roughly 30% annual pace from early 2010 until recently. In relative terms, Argentina's money supply expanded by about 25% more every year than did our M2.

Chart #3

In theory, much more rapid growth in Argentina's money supply should have resulted in a roughly 20% annual decline in the value of the peso. Chart #3 illustrates this (green line). Note that in recent months the peso fell by much more than would be suggested by its rate of monetary expansion: this is a measure of the panic selling that typically precedes periods of consolidation. With the peso at extremely cheap levels, the market was ripe for a positive shock, which the central bank fortunately was able to deliver in the form of a "no more money printing" pledge.

Chart #4

Chart #4 shows the dollar value of Argentina's Merval (stock market), which has plunged by 57% since early this year. All the gains that accompanied the election of Macri and the subsequent massive capital inflows have been reversed. If Macri and his new central bank leadership team can stay the course, the upside potential of this struggling emerging market economy is HUGE.