Thursday, September 25, 2014

Argentina: a slow-motion train wreck

The Argentine economy is in recession, the central bank's forex reserves are dangerously low, having fallen by almost half in the past few years, and inflation is raging. Worst of all, the government is doing everything wrong. Its peronist/populist president is completely out of touch with how economies work, and its economy minister is a young, starry-eyed socialist and former economics professor who wouldn't be able to get a teaching job in the U.S. to save his life. 

Under Argentina's pegged exchange rate system, a loss of reserves is an unambiguous sign of capital flight: more money wants to leave the country than wants to come in. To enforce its currency peg, the central bank must sell dollars to accommodate those who want out. With reserves now critically low, the central bank has taken the further (and inevitable) step of rationing access to the official exchange rate. This means that those who want out are forced to use the parallel—or "blue"— currency market.

The problem started about four years ago. Once the government started rationing access to the official peso rate, a parallel, or black market for dollars soon developed and the official and "blue" rates started to diverge. The current gap between the blue rate and the official rate is now more than 70%, a sure sign that confidence in the peso is extremely weak. As the chart above shows, a similar gap opened up in the second quarter of last year, and it preceded a major devaluation of the official peso by some 8 months. Another official devaluation is almost certain, and with it should come even higher inflation and a further loss of confidence. Unfortunately, Argentina's leadership does not understand what is happening and refuses to take the appropriate corrective action, so hope for improvement is nil.

Fixing things would, among other things, require a substantial tightening of monetary policy. For years, Argentina's central bank has expanded its balance sheet in classic "money printing" fashion, by lending significant sums of money, mostly in the form of newly-printed currency, to the government, in exchange for a flimsy promise that it will be repaid. Argentina is literally a proving ground for the theory that when too much money (actual peso currency) chases a limited amount of goods, the result is inflation. As the chart above shows, the amount of pesos in circulation has increased at a 30% annualized rate for the past five years, even as the demand to hold pesos (people would much rather have dollars) has plunged. A rapidly rising money supply and a declining demand for that money is nothing less than a perfect inflation storm.

Fixing things would also require a return to free market policies, a commitment to a stable peso (e.g., something like dollarization), free capital flows, and a recognition that past debts must be honored. Unfortunately, the current government is loathe to even consider such measures, even though they could produce powerfully positive results.

Watching Argentina implode is like watching a slow-motion train wreck. It's inevitable and terribly destructive, and all for no purpose except to enrich the ruling class.

Venezuela is in much worse shape than Argentina, and Brazil is in a recession, and the Brazilian real is once again in decline. Even Chile, which had been doing so well for so long, is succumbing to bad policy decisions, with the result that its economy is slowing, inflation is rising, and the Chilean peso is falling. South America is in a world of hurt, with no lifelines on the horizon.


steve w said...

All it takes is a combination of direct democracy and an ignorant electorate and ANY economy can be destroyed by the elites astute use of lefty populist laws and demagoguery.
Glad the good ole USA isn't so afflicted. So glad we have politicians that only seek to educate our voters about economic matters because they are enlightened enough to realize the grave danger that ignorance poses to a strong economy. Yes, I sleep soundly at night knowing we are immune to such clap trap.

Grechster said...

SG: Would be interested in your thoughts on the following issue...

As of, say, August 1, I had finally gotten somewhat comfortable that the Fed had pulled off a monetary environment that supported the notion of stability. Monetary stability. Gold had been in a tight band for almost a year and a half. The DXY was in a reasonably tight two-year band too (no small feat!). We were all disappointed in the degree of economic growth but the Fed had played its role pretty well in terms of eliminating monetary instability.

During this period of time, I was thinking that the hand-off to a more fiscal policy-driven growth environment would be appropriate, and very needed. I kind of stopped mentally beating up on the Fed. (I'd very much prefer an asset-backed currency instead of the fiat lunacy that we have but that's another topic. Once we accept that were in a fiat currency system, I'd come to grudgingly give the Fed respect based on the two-year stability it'd pulled off.)

We can all agree we need better growth policies out of Congress and the White House. But what the heck has happened to the monetary stability that I had just come to feel ok about? Gold is legging down and the dollar has put on an incredible move in a short period of time.

We all know about the moves (or lack thereof) of Japan and the ECB. We also know that the longer term chart of the dollar suggests that the recent strength is nothing in the grand scheme. The Fed knows these things too. My question: Has the Fed lost control of the monetary stability it seemed to so carefully construct over the last couple years? While the media deliberates over whether Fed Funds will increase in March or in June, the markets seem to be screaming that the Fed is too tight. Why is the Fed doing this?

NormanB said...

Latin America's problem is that the people there believe in the 'free lunch' economic model. They are stupid and childish. A politician, any politician, will say anything if people will believe it and vote her/him in. It worked for Obama so I'm guessing we are becoming more like Latin America.

Scott Grannis said...

Re: is the Fed too tight? I don't see any sign in the market that the Fed is too tight. If they were, the yield curve would be flat or inverted, gold would be below its long-term average (in real terms) of $650 or so, commodities would be a lot lower, swap spreads would be a lot higher, credit spreads would be a lot wider, the stock market would probably be a lot lower.

What I do see is that the market is adjusting to a reality that is better than it expected. Gold was priced to a lot of inflation which hasn't happened. The dollar was very depressed, now it's getting back to "reasonable" territory. Commodity prices are coming off their highs. Swap spreads are well within a "normal" range. Equity PE ratios are only modestly above average.

Benjamin Cole said...

On the other hand, years and years of "easy money" does not lead record-low interest rates and inflation like we have now. We may yet see a collapse of gold and oil prices.

Unknown said...

Please explain why you are expecting a collapse in gold and oil prices due to the easy money policy. I suspect the record low interest rates and possible collapse of oil and gold would be due to lack of global demand.

William said...

The Conference Board Leading Economic Index® (LEI) for the U.S. increased 0.2 percent in August to 103.8 (2004 = 100), following a 1.1 percent increase in July, and a 0.7 percent increase in June.

“The LEI continued to rise in August, although at a slower rate than in July,” said Ataman Ozyildirim, Economist at The Conference Board. “The LEI’s six-month growth trend has been held back slightly by lackluster contributions from housing permits and new orders for nondefense capital orders. Despite concerns about investment picking up, the economy should continue expanding at a moderate pace for the remainder of the year.”

“The leading indicators point to an economy that is continuing to gain traction, but most likely won’t repeat its stellar second quarter performance in the second half,” said Ken Goldstein, Economist at The Conference Board. “Meanwhile, the CEI, a measure of current economic activity, continued to expand through August, amid improving personal income, employment and retail sales. However, industrial production registered a slight decrease for the first time in seven months.”

The Conference Board Coincident Economic Index® (CEI) for the U.S. increased 0.2 percent in August to 109.7 (2004 = 100), following a 0.1 percent increase in July, and a 0.3 percent increase in June.

Benjamin Cole said...

Bodin: We agree. Demand is weak. Defeatism is the order of the day. I used quotation marks on "easy money."

William said...

OECD Composite leading indicators continue to point to stable growth momentum in most major economies (14 Sept 2014)

Composite leading indicators (CLIs), designed to anticipate turning points in economic activity relative to trend, continue to signal a stable growth momentum in most major economies.The CLIs for the OECD area as a whole as well as for the United States, Canada and the United Kingdom continue to point to stable growth momentum.

The CLI for Japan continues to indicate an interruption in growth momentum though this may be related to one-off factors.

In Germany the CLI continues to point to slowing momentum, whereas in Italy the CLI exhibits tentative signs of a loss of growth momentum. In the Euro Area as a whole and in France, the CLIs remain stable.

In India growth continues to gain momentum while in China and Russia CLIs point to stabilisation of growth. The CLI for Brazil suggests a tentative upward change in momentum.