The Argentine Peso’s Death Spiral
A sharp selloff of the Argentine peso is sparking new inflation fears in South America’s second-largest economy. For a country that is heavily dependent on foreign capital and has a history of repeatedly destroying its currency, this is no passing storm.
The return of the International Monetary Fund to Argentina last week with a $30 billion emergency aid package is proof that the government is in panic mode. But outsiders can’t fix this problem, and IMF austerity is likely only to rekindle isolationist sentiment.
Any rescue has to start with President Mauricio Macri explicitly backing the central bank’s independence so that the monetary authority can restore its credibility. That effort was under way in the first year of his presidency, which began in December 2015. But a persistent fiscal deficit, inadequate regulatory reform and slow growth have put increasing pressure on the central bank to print money and lower interest rates.
The idea that easy money can substitute as a fix for underlying structural problems wasn’t born in Argentina. Barack Obama and Federal Reserve Chairs Ben Bernanke and Janet Yellen tried it for eight years after the 2008 financial crisis. Yet U.S. growth didn’t pick up until the Trump administration began to cut taxes and reverse an antibusiness bias.
It’s astounding that Argentina would administer something similar to the Obama-Bernanke elixir, and not only because the U.S. dollar’s reserve-currency status is a unique privilege. Argentina has a terrible monetary reputation that can be overcome only by demonstrating a firm commitment to price stability. Germany learned this lesson in the period between World War I and World War II. Argentina keeps reliving it.
The peso is down more than 15% against the dollar in the past three weeks. The central bank has responded by hiking overnight interest rates to 40%. Since April 19 it has sold around $8 billion in international reserves in a futile attempt to reverse the slide. Credit-default swaps spiked last week.
Mr. Macri is blaming the peso rout on rising dollar interest rates, higher oil prices and “other variables that we don’t manage.” But as I noted in a February column on this topic, Argentina’s deeply rooted culture of populism is the original sin, and Mr. Macri’s reluctance to confront it threatens his success.
The president inherited a fiscal mess from his predecessors, Cristina Kirchner, who was president from 2007-15, and her husband, Néstor, president from 2003-07. But the Kirchners also sowed deep social division with hateful, vicious rhetoric as a strategy for remaining in power. Mr. Macri has sought to heal the nation with a kinder, gentler message from the Casa Rosada presidential office.
Yet sugarcoating the grim economic reality is no way to build consensus for change. It is impossible to generate support for better policy without a conversation in the public square about how economic nationalism—a k a Peronism—has cost the country.
Only a leader willing to make the case for smaller government and greater economic liberty—every day—can begin to right the ship. If Mr. Macri can’t do this, he should hire a team of communicators who can.
The president has instead opted for gradualism, which is a code word for soft-pedaling the sad facts. More than two years into a four-year term, he hasn’t made a dent in aggregate government spending, and, as important, tax, labor and trade policy remain too restrictive.
In 2002, the year before Néstor Kirchner took the reins of power, the consolidated government budget was less than 23% of gross domestic product. When Mrs. Kirchner left it was over 41% of GDP. In other words, there is plenty of fat to cut. Yet the overall fiscal deficit in 2017 was 6.5% of GDP, slightly larger than when Mrs. Kirchner stepped down.
Mr. Macri’s first year in office was promising. By October 2016 the exchange rate had been freed, and the central bank was gaining credibility. Inflation was annualizing at more than 44% but the government was able to issue 10-year bonds with a 15.5% coupon.
That may have been because the bank had set an inflation target of 10% for 2018. But in December it raised that target to 15% and subsequently began cutting the overnight lending rate. At the same time the government lobbied, not so subtly, for a weaker peso. The idea was to spur growth to generate more government revenue. It was a mega-miscalculation.
Financing a fiscal deficit in a country without national savings means importing capital, which naturally generates a current-account deficit and a currency that is stronger than it would otherwise be. Creditors were willing to finance the large budget deficit. But the peso devaluation has them heading for the exits, setting off a death spiral and raising inflationary expectations.
Mr. Macri wants Argentina to return to normalcy. But asking the central bank to bear the cost of runaway populism is no way to get there.