Good news: Argentina nears another devaluation

Argentina is approaching the point at which a devaluation of the peso (i.e., replacing the official exchange rate with a freely accessible market-based rate) is almost inevitable. Paradoxically, this will be good news for Argentina, at least for awhile. Ideally, Argentina should dollarize its economy, but that probably is too much to expect from a regime which is almost hopelessly corrupt.

The above chart traces the inexorable decline of Argentina's currency since 2007. Since its last iteration at the beginning of 1992, when it traded at 1 to 1 against the dollar, the peso has lost 99.8% of its value. In fact, the peso has been falling for more than a century. Back in 1916, the peso traded at 2 pesos per dollar. Since then, Argentina has changed its currency four times, each time lopping multiple 0's from its nominal value. If the original peso were still in circulation, it would be trading today at 4,580,000,000,000,000 to the dollar!

A new peso, or at the very least a new currency regime, in which the peso's value is determined by market forces instead of by government decree, is just around the corner. We know that because government officials are once again denying that there will be a devaluation. Anyone, like me, who has lived in Argentina long enough knows that official denials of an impending devaluation are a sure-fire signal that it is going to happen. We also know it because the current situation—inflation now exceeds 100%, the currency has lost over half of its value in just the past year, and interest rates exceed 80%—cannot go on forever. As a practical matter, since the largest denomination peso bill in circulation ($1000 pesos) is worth only $2.20 dollars, the average person must walk around with a huge roll of bills just to make incidental purchases. (A new $2000 peso bill has been authorized, but that won't fix the problem.)

The only unknown at this point is whether Argentina will continue to use pesos with a floating (i.e., market-based) exchange rate or whether it will dollarize its economy. The latter would be the best solution, but that's probably a bridge too far for the current bunch of corrupt politicians, since it would require a massive reduction in government spending. Throughout history, the Argentine government has financed deficit spending by resorting to the printing press. Printing money is a pernicious form of taxation, since anyone who holds onto currency that loses value on a daily basis is effectively paying a tax to the government in the form of lost purchasing power. Corrupt politicians have long known that printing money to pay for spending (which, in turn, helps buy votes) is much easier than cutting spending or raising taxes.

Lest we forget, our own government did precisely this in 2020 and 2021, when some $6 trillion of Covid "emergency" spending was effectively financed by a $6 trillion expansion of the M2 money supply. (I began explaining this way back in July '21.) That was the proximate cause of the inflation nightmare from which we are now waking up.

Paradoxically, a devaluation would likely be good news for Argentina, at least for awhile. That's because the current regime—which features an "official" rate of $220 pesos per dollar and a "blue" or parallel rate of $450 per dollar—discourages investment and tourism. If a tourist uses a credit card in Argentina, pesos get translated at the official rate instead of the market rate, which means things cost about twice as much as they would if the tourist used dollars exchanged at the "blue" or parallel rate. Similarly, most foreign exchange which passes through the banking system is processed at the official rate, and that amounts to a severe impediment to foreign investment.

A devaluation would be a boon to Argentine exporters since their export sales would be exchanged at 450 pesos rather than 220. Moreover, it would likely spark a huge inflow of foreign capital since investors would feel more comfortable knowing that they can get a market-based rate for their investment dollars—and it would be much easier to withdraw money in the future if they so chose. Plus, over the years Argentines have stashed hundreds of billions of dollars overseas, and at least part of that would be repatriated following a devaluation.

For more information on Argentina, I have written extensively on Argentina in this blog.

P.S. There are several alternatives that Argentina can choose from at this juncture: 1) eliminate all of the many official exchange rates (as much as a dozen in fact) in favor of a single, market-determined rate, 2) replace the peso with a “new” peso that has an exchange rate of, say, 4.5 to the dollar (thus lopping off two zeroes) while also unifying all exchange rates in one floating rate, and 3) dollarization, which would involve replacing pesos with dollars at an exchange rate of, say, 4.5 to the dollar. 

Door #3 would be the best, but also the hardest to implement, since Argentina would need the cooperation of the US Treasury and it would also need to permanently slash its bloated spending, because it would most likely be impossible to borrow all the money they are currently spending via the printing press. The reward to a successful dollarization would be the effective cessation of inflation, combined with a flood of new foreign investment and a surge in confidence—and ultimately a booming economy. Door #2 would be equivalent to what the government has done several times in the past, but it would require a cumbersome period during which old pesos could be exchanged for new pesos, and it would not force a reduction in spending or inflation. Door #1 is the easiest to implement, since it would require only a change in the laws governing currency transactions, but it would not require the government to curtail spending by enough to significantly reduce the current high level of inflation, which is ultimately the driving factor behind the plunging peso. Doors #2 and #3 would, however, provide some stimulus to the economy since they would likely lead to some new foreign exchange inflows and new investment. That’s because having one free-floating exchange rate is much more efficient than having several government-controlled rates.

P.S. (July 21, 2023): Since I wrote this list the Argentina Fund ETF (ARGT) is up over 20%. It's one of the strongest performers YTD, and over the past 5 years it has almost equaled the performance of the S&P 500. Who would have thought that the (arguably) worst country in the world, plagued by 100+% inflation and a disintegrating government, would deliver such amazing performance? My explanation: things were so bad in Argentina that they could hardly get worse, and now there is a glimmer of light at the end of a very dark tunnel. 

P.P.S. (August 14, 2023): Jorge Milei swept the presidential primary yesterday, surprising nearly everyone. He was my favorite, but most observers, including myself, thought he couldn't possibly win. I see this as great news for the long-term health of the country, but for the moment markets are taking it as bad news—thinking (correctly) that Milei would devalue the peso. Equities are down some 5% and the official exchange rate was devalued some 13% today. The "blue" rate is down 6% today. But here's the thing: Milei wants to ditch the peso, in order to replace it with something solid, like the dollar. That's what Argentina needs most of all. Assuming he is successful, investors should be anticipating huge upside potential for Argentine assets, not dumping them. But for now, uncertainty rules the day; the official election is still months away. Argentine assets are going for fire-sale prices now; they may get cheaper still, but Milei's victory is a sign that a revival is in the cards. Yesterday there was no hope for Argentina; today there is plenty.

P.P.P.S (October 9, 2023): It's still uncertain who will be Argentina's next president, but it is increasingly likely that it will be either Javier Milei or Patricia Bullrich. Both have good ideas that ought to brighten the long-term outlook. But the uncertainty—coupled with massive money-printing—has all but destroyed demand for the peso. The pressures are coming to a head, with elections just around the corner. Here's an update on the peso (official vs. blue); the blue rate is now intolerably weak vs. the official rate, while reserves are virtually exhausted—something big will happen soon: