Tuesday, March 27, 2012

Argentina, the land of deja-vu all over again

This is a follow-up to a post from last October, in which I discussed how the massive devaluation of the Argentine peso in early 2002 has translated almost one-for-one into higher inflation, very much as monetary theory would predict. I also mentioned how the government has been trying in vain to "suppress" inflation by gaming the CPI (first chart above).

Five months later, the story is the same, only now things are starting to get worse. As the second chart shows, true inflation is now double the "official" rate shown in the first chart. Since the peso was first pegged at 1:1 to the dollar in 1993, the price of a dollar has gone up by a factor of 4.4, and the price level (as measured by the GDP deflator) has gone up by a factor of 4.2. Confidence in the economy and the government is declining; the government has tapped the central bank's reserves to make payments on its international debt; in order to arrest capital flight which was also draining the central bank's reserves, the government has imposed exchange controls and restrictions on imports (many of which are not being granted, thus threatening to shut down the economy); and predictably, the exchange controls and import restrictions have led to the emergence of a "black market" for dollars.

I have been following developments in Argentina closely for the past 40 years, and I have lost track of the number of times that the government has meddled with the economy in ways which inevitably lead to inflation, devaluation, and economic collapse. I've seen this movie so many times it's like watching a slow-motion train wreck. The gap between the black market and the official exchange rate (now 5.25 and 4.4, respectively) will widen, more capital will leave the country, new investments will slow to a crawl, the economy will slump, and the government will eventually engineer one more in a long line of major devaluations. This in turn will provoke an inflationary recession and impoverish the private sector (the purpose of devaluations for countries like Argentina is to transfer wealth from the private to the public sector). As the dust settles, capital will begin trickling back in, import and exchange controls will be lifted, and the economy will slowly get back on its feet, but only at great cost in lost output and lower living standards for nearly everyone. It's a tragedy that has played out dozens of times in the past 40-50 years, but politicians never seem to learn, always thinking that they can outsmart the market—and line their pockets in the process.

Argentina is living proof that capital only resides in countries where it is respected and allowed to move freely. If capital is not free to leave, exchange controls only create a huge incentive for resourceful citizens and companies to skirt the controls and move money offshore, while destroying confidence and investment in the process. Unless President Kirchner comes to her senses quickly, which I doubt, the economy is doomed to suffer yet another painful recession.

We'll be spending a few weeks in Argentina next month, so I'll have the "privilege," that only an economist can enjoy, of watching how declining demand for pesos leads to higher prices even as the economy declines. The last time I saw this happen, prices almost tripled in the space of three weeks; I hope it won't be so bad this time.


M. Vivaldi said...

Great article Scott!
Given the fact that they are not only meddling with the CPI but also now with the exchange rate... do you know if there is a series of the unofficial peso-dollar rate?

It would be interesting to graph the two different real value of the currencies.
The totally fictious "INDEC CDI+BCRA ARS/USD" and the real "PriceStats+BlueChipARS/USD"


Donny Baseball said...

At the risk of being insensitive to needless suffering, which I am not, Argentines get the government they deserve. It is hard to sympathize when they consistently return Peronist buffoons to office. I'm afraid Argentina is doomed to suffer the consequences of their own bad collective judgement.

Scott Grannis said...

Matias: I'm not aware of a series for this. The peso black market comes and goes, and has only been active for the past several months.

Scott Grannis said...

Donny: You are absolutely right, and most Argentines would agree with you. Why they continue to repeat the errors of the past is one of the great mysteries of Argentina.

Benjamin Cole said...

Repeat errors of the past?

Why does the USA repeatedly invade and then enter into long-term occupations of whole nations, events that yield meagre fruit at fantastic expense?

Why does Japan maintain the strongest currency in the West, resulting in the weakest economy in the West (below socialist statist Italy, Netherlands France etc) for more than 20 years?

Governments seem unable to change. Bureaucratic imperatives do not respond to economic signals.

You get creative destruction in the private sector. That does not happen to federal agencies.

The USA will outlay $1.4 trillion just for the VA in the next 10 years---and that assumes no inflation and no more wars.

Squire said...

One the corrupt liberal patronage system reaches critical mass, like in California, you cannot undo it.

Benjamin Cole said...


Or rural subsidies---go to The Tax Foundation. The most heavily subsided states in the union are rural states, sometimes getting back as much as $1.50 or more for every dollar sent to DC. A state like KY (Senator Mitchell and young Paul are Senators) gets about $4,000 in net subsidies for every man, woman and child in the state. They float on top of federal lard.

You heard Gingrich on farm subsidies? He just said there is nothing you can do. Too tough a nut to crack.

Clinton in fact instituted welfare reform. I would like even less welfare, and delayed Social Security benefits (and I am still under 62, so this applies to myself).

But the defense-homeland security-VA-USDA is a lard-patronage complex here forever.

PD Dennison said...


Thanks for the update.

Looking forward to hearing about your trip.

Do include some pictures. The government cannot screw-up the scenery too much!

Benjamin Cole said...


The DJIA closed at 9319 on Nov. 3 2008. That was a close election, and no one knew who would win House, Senate or WH.

Now we are 13k or so. So we are up up 40 percent on Obama's watch.

We dropped about that much after nearly 8 years of GOP-dominated DC. We were also stuck in two interminable wars, and our financial system had collapsed and even GM was bankrupt.

I would say Obama inherited a train wreck into a stage treatment facility, known as the Bush Administration.

Not only I thought that: Incredibly, Bush jr., a sitting GOP president, was not even invited to the GOP convention, an unimaginable occurrence. His name is mud in GOP circles to this day (well, bona fide conservative GOP circles).

Obama had to play the weakest hand ever dealt to a President, and he has not played it particularly well. I think he should have tried to reform Dems into a pro-business party. Strip down welfare to one single check a month to beneficiaries, and no food stamps, housing programs, socials welfare service. KISS.

Bush jr. after 9/11, had a chance to develop a much, much leaner defenses, geared to the present minute threat of terrorism. He failed too, and just added another huge ($400 billion annually) layer of fat on onto the defense-VA-homeland security blob.

We spend $1 trillion annually on Defense-Homeland Security-VA, or about $3333 for every resident of the USA. $13k for a family of four, and more every year.

Obama has done nothing about that either.

Ron Paul is an interesting candidate.

Romney says he wants to spend even more on defense. That he ill not tax his NASCAR buddies to finance.

Squire said...

When I said once the corrupt liberal patronage power structure reaches critical mass it cannot be undone, I didn’t mean democrats. I meant the blue model like Walter Russell Meade talks about it. It is way more developed in Argentina and other countries than in the U.S. Except California.

depre forever said...

I am writing you from Argentina, and I want to say that you are totally wright.
We fall in the same mistake over and over again.
It seems to be impossible to change the mental illness of the politicians and almost the mayority of the population in this ex-country.
I cannot be optimistic with 90% of the people thinking the same way.

Scott Grannis said...

A series that covers the value of the unofficial (black market) peso exchange can be found on Bloomberg: .IMPARS G Index

The unofficial rate diverged from the official rate last October when the government began imposing exchange controls.