The week of July 22, 2024: Javier Milei’s hyperinflation win, tax, labor, planning, The Olympics, and much, much more.
The week of July 22, 2024: Javier Milei’s hyperinflation win, tax, labor, planning, The Olympics, and much, much more.
My most recent article for National Review is about Argentina’s new anarcho-capitalist president, Javier Milei, and his success (so far) in averting what looked like an inexorable descent into hyperinflation. It was written after visiting Buenos Aires to attend a conference jointly organized by the Cato Institute and an Argentine free-market think tank, Libertad y Progreso. It was not the first time that I had been to Argentina, but the fourth. The first was in 2010. Officially, inflation back then was running at an annual rate of 10.9 percent, but the real rate was widely thought to be at least twice that.
In a New York Times article from early 2011, Alexei Barrionuevo noted that the government then led by Kristina Kirchner, a left-wing Peronist, who had succeeded her similarly-inclined husband, Néstor, as president in 2007, was insisting that inflation was not a problem. This was despite “substantial evidence…that the government’s national statistics agency has been grossly underreporting inflation and poverty.”
By the time I returned to Argentina in 2011, the government had criminalized the publication of “false” data about inflation, which was to say data that contradicted the numbers that had been cobbled together by the government’s national statistics institute (INDEC). Camila Russo and Bill Faries, the authors of a report published in Bloomberg in July 2011, described allegations that messing around with the numbers had been going on since January 2007, when then-President Néstor Kirchner began changing personnel at INDEC in a bid to “improve operations.”
The ratchet had turned some way by 2011:
Argentina stepped up its pressure on economists who say the government has underestimated inflation in its official reports for more than four years by filing criminal charges against research company M&S Consultores SA.
Interior Commerce Secretary Guillermo Moreno filed charges against M&S on July 8, saying the company stood to profit by claiming prices in South America’s second-biggest economy are rising faster than the 9.7 percent annual rate reported by the national statistics institute. In February the government began fining economists 500,000 pesos ($121,000) for saying prices were rising as much as 25 percent per year.
The Dólar blu (the “informal” exchange rate) is now around $1 to 1,400 pesos, meaning that 500,000 pesos is worth about $350 today, a long way down from $121,000. When Russo and Faries were writing, the Dólar blu was at around 4.25 pesos, a modest spread over the official rate. Today the principal official rate is about 900 to the dollar. The credit-card wielding tourist (MEP) rate is around 1,300.Multiple exchange rates are not a sign of an economy in rude health.
In 2011, simply comparing prices from my earlier visit the year before led me to think that inflation was in the mid-20s (compared with the official rate of about 10 percent). In Santa Fe, a medium-sized city 300 miles northeast of Buenos Aires, an elderly schoolteacher told me that my inflation guesstimate could well be too low. A rarity in the Argentina of 2011, she had stuck with the classical liberal (more or less) thinking of her country’s golden age. That had been around the turn of the 20th century, when Argentina had been one of the richest countries in the world. She was delighted to meet a foreigner who had heard of Domingo Sarmiento (1811-88), a 19th century president who was an embodiment of that lost classically liberal vision of Argentina.
I digress (well, this is the Capital Letter), but, although Milei describes himself as an anarcho-syndicalist, he often refers back to something less scary, the Argentinian classical liberalism of over a century ago. He frequently cites Juan Alberdi (1810-1884), the most influential political theorist of that time and, in many respects, one of those most responsible for the country’s heavily U.S.-influenced 1853 constitution.
To get a flavor of Alberdi’s thinking, here’s a sentence from his Sistema económico y rentístico de la Constitución Argentina:
The law could not have the power to make individuals equal in outcome, because it would have to violate liberty and property, and this process of giving to some and taking from others could not exist under the system of a constitution that treats everyone equally as the essential foundations of the country’s laws.
Alberdi would not have liked what he saw of the Argentine economy in 2011. Its healthy GDP growth had been helped on its way by a turn to deficit spending after a couple of years in surplus. A course was being set for the next few years, except for the growth, which either shrank or disappeared altogether. By 2017 Argentina was running a budget deficit of around 6 percent. Meanwhile, denied access to the international capital markets until 2016 by a long running legal dispute following the country’s default in 2001, it had increasingly relied on funding itself by printing money.
A center-right president, Mauricio Macri, had been elected in 2015 to stop the rot, but, after a reasonablestart, the rot prevailed and Macri lost his bid for reelection to another Peronist, Alberto Fernández, in 2019. Matters deteriorated further as Fernández’s attempts to revive the economy, often by recourse to command-and-control methods, made things worse. The budget deficit stopped easing and hit 8.4 percent in 2020 (thanks also to Covid), before returning to 3.6 percent in 2021, and drifting on up from there.
In 2020, Argentina defaulted (yet again) on its sovereign debt, meaning that, with the principal exception of the IMF, it had to turn to domestic lenders or to the printing press: M2 moved up sharply between January 2020 and January 2022, then plateaued at a high level for much of 2023. Inflation shot up. In 2021, it stood at 48 percent, in 2022 73 percent, and in 2023 seemed en route to hyperinflation, reaching 142 percent in October, the month before Argentines, desperate to try something new, elected Milei as their president.
Adding to the risk of hyperinflation was the danger that Argentina was going to enter a period of fiscal dominance. In a Capital Letter in April, I wrote about the possibility that the U.S. might face this problem at some future date. Charles Calomiris had explained what this meant in an article for the St. Louis Fed:
Fiscal dominance refers to the possibility that the accumulation of government debt and continuing government deficits can produce increases in inflation that “dominate” central bank intentions to keep inflation low.
To put it bluntly, it refers to a situation in which a country’s finances have deteriorated so badly that its central bank can no longer keep control.
Calomiris:
The essence of fiscal dominance is the need for the government to fund its deficits on the margin with non-interest-bearing debts. The use of non-interest-bearing debt as a means of funding is also known as “inflation taxation.” Fiscal dominance leads governments to rely on inflation taxation by “printing money” (increasing the supply of non-interest-bearing government debt).
As Calomiris had explained, the moment of crisis occurs “when the bond market begins to believe that government interest-bearing debt is beyond the ceiling of feasibility,” a moment brought closer as the interest rate needed to attract buyers moves up, a process that cannot continue indefinitely. At some point, a government bond auction will “fail” in the sense that the interest rate required by the market on a new bond offering is so high that the government withdraws the offering and turns to money printing as its alternative.
Argentina had arrived at a not dissimilar point.
Lack of access to international markets (something, of course, that worsened Argentina’s chronic shortage of foreign exchange — a topic for another day), coupled with lack of “normal” demand at home, meant that the rate at which the central bank (BCRA) was printing money to finance the debt was accelerating at an alarming pace. Much of this took a curiously byzantine form, explained by the need to get domestic banks to help mop up the amount of money that was being printed, and maybe — this could be a conspiracy theory too far — to add some helpful opacity to the state of the nation’s finances.
In an article for the Cato Institute, Daniel Raisbeck explained:
At the end of the [Fernández] government, Argentina faced triple-digit annual inflation levels due to the entrenched practice of monetizing the debt incurred to finance profligate spending. One of the main drivers of inflation was the mountain of interest-bearing liabilities on the central bank’s balance sheet, worth around USD $30 billion. Known as liquidity notes (Leliqs), these liabilities had very short-term maturities, ranging from 24 hours (notes known as Pases) to 28 days (with a rollover mechanism), and an effective annual interest rate of 155 percent when inflation stood at around 130 percent per annum. Only the commercial banks had access to the Leliq market, so Argentine banks, through mere access to the central bank, had one of the highest Return on Assets ratios in Latin America. But the only way for the central bank to finance the Leliq scheme was by issuing more Leliqs. At one point it was issuing the equivalent of the entire monetary base every five months. Hence the very real possibility of hyperinflation.
In December, the Argentine thinktank Idesa estimated that outstanding Leliqs and Pases amounted to almost three times the monetary base. There had been a lot of mopping up. Moreover, the BCRA was paying the banks who were buying the Leliqs and Pases more interest than it was receiving from Argentina’s treasury. Adding the cost of that spread to the fiscal deficit would mean that it was not 4.4 percent, but more than twice that.
Idesa also noted that the maturities of these securities were shortening. In August 2023, 73 percent of the short-term notes outstanding were Leliqs and 27 percent Pases (one-day repo operations). By December, those proportions had reversed, a clear warning sign.
The BCRA was only following orders, but it’s easy to understand why Milei wanted to “burn it down.” The existence of a compliant central bank with the power to print money is a temptation to feckless governments, as Alberdi had warned:
As long as the government has the power to produce money with mere pieces of paper that promise nothing nor force any repayment, the all-embracing power will live unaltered as a worm eating at the heart of the very Constitution.
Writing long before the foundation in 1935 of the BCRA, Alberdi had strong views on how to deal with a central bank:
The reform of a bank of the state is impossible. There is only one way to reform it: eliminate it.
Milei would agree. Rather than stocking up on gasoline and matches, his campaign included a pledge to replace the peso with the dollar. Whether that would be a good idea remains fiercely debated (another topic to be discussed), but for now any switch remains on hold.
Once Milei assumed office, his finance minister, Luis Caputo, started to tackle the Leliq problem, beginning the process of transferring the BCRA’s liabilities to the treasury, and cutting the interest rates paid on new Leliqs (to below the inflation rate) and lengthening their maturities. This would allow inflation to eat away at the debt. This appears to have been working well. Prior to assigning the BCRA’s debt to the treasury, its debt had fallen by about a half in real terms, and the interest burden (on that debt) had dropped from around 10 percent of GDP to 3 percent (data via Bow-Tied Mara). Overall, the interest payable on the consolidated debt (the state’s debt plus the former BCRA debt) has fallen from 12 percent of GDP to 4 percent.
Argentina being Argentina, banks would need some sort of insurance before buying paper on these terms. They received this in the form of put options (the right to sell a security back at a certain price, in this case, to the issuer).
Raisbeck:
[The puts] in effect, [create] a floor that protects the buyer (i.e. the banks), with a guarantee from the central bank to rebuy the Treasury bonds at the strike price in case bond prices drop far below face value. Currently [Raisbeck was writing in early July], around USD $21 billion of Treasury bonds are “insured” through puts, with around 50 percent due to expire in 2026 and 2027. If the options were to be exercised instantly during a bond market rout…the central bank would only be able to pay the commercial banks by issuing the money ex nihilo.
In other words, a deluge of newly created pesos would be released into the banking system, undoing all efforts to ease inflation. This risk has been substantially reduced by the government’s purchase in recent weeks of more than half the outstanding puts. Caputo tweeted that another bomb had been defused.
The transfer of the BCRA’s obligations to the treasury is also being wrapped up, with the one-day repo operations (the Pases) being replaced by new one-year Fiscal Liquidity Bills (LEFI), another part of the strategy to halt peso-printing. Writing in the Buenos Aires Herald, Juan Strasnos Peyre noted that “from now on interest will not be financed by issuing pesos, but by the treasury shouldering the payment through an additional adjustment in other budget items.” To put it another way, if there is trouble meeting interest bills, expenditure will be cut, or taxes increased. It’s another step away from hyperinflation and towards returning the financing of the Argentine state to respectability. Ratings agency Fitch, however, notes that the BCRA has the right to buy LEFIs, “leaving a route open for peso creation.” This presumably would only be in the case of emergency, but emergencies are not unknown in Argentina.
Fitch also notes that the combined total of peso securities held by the BCRA and treasury continue to increase, basically because some interest is capitalized. This does not show up in the deficit numbers. For his part, Nicolás Cachanosky of the University of Texas observes that Argentina’s monetary base is growing rapidly, something that Caputo puts down to technicalities. In part, perhaps, but worth watching.
And the (remarkable) run of fiscal surpluses that the country has run over the past six months will be difficult to sustain. As I mentioned in my article, the cuts that did so much to make them possible were crudely done. No doubt there will be strong political pressure to make some adjustments that Milei, whose party has a very weak position in congress, will find difficult to resist. Moreover, it seems clear that the numbers were flattered by some payments being deferred. They cannot be deferred indefinitely.
It seems remarkable to write that Milei’s government appears to have seen off hyperinflation when the annual rate is (as of June) 271 percent, but the monthly rate had fallen sharply for five consecutive months down to 4.2 percent in May, as against 25 percent in December (and 21 percent in January) in the wake of a 54 percent devaluation of the peso. In June, the monthly rate ticked up to 4.6 percent, in no small part because of significant reductions in subsidies for utilities bills and other goods and services. Those subsidy cuts are part of the anti-inflationary cure, but they make the disease worse in the short-term.
If Argentina is emerging from its prolonged economic malaise, it is, to quote, Churchill, only at the end of the beginning, if that. There are numerous problems ahead, of which the most pressing, to which I also referred in the article, is the growing overvaluation of the peso. Following the December devaluation, the peso was locked into a crawling peg (to the U.S. dollar), under which it depreciates by 2 percent a month. Monthly inflation has, as stated above, been far ahead of that, leaving the peso overvalued. The spread between the Dólar blu (around $1 to 1,400 pesos) and the principal official rate (around $1 to 900 pesos) gives some indication of how great that overvaluation may be. The government is under pressure to at least accelerate the rate of depreciation to ease the strain on the economy. But accelerating the peso’s depreciation will give a fillip to inflation. Milei, confident that inflation will fall below 2 percent a month on its way down to even lower levels, intends to stay the course, but will he be able to?
To be continued…
The Capital Record
We released the latest of our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears weekly, makes use of another medium to deliver Capital Matters’ defense of free markets. Financier and National Review Institute trustee, David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by the National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 180th episode, David is joined once again by macro-intelligence icon Rene Aninao. They wax and wane about the 2024 presidential election, but then spend a lot of time on China, Russia, and other hot spots of the world, where the new weapons are . . . economic.
The Capital Matters week that was . . .
Transportation
In almost a decade working for the British Department for Transport, no officials impressed me as much as the accident investigators. They were dedicated experts who focused on what actually happened in a transportation accident, and what recommendations would prevent it from happening again. Their American equivalents have set themselves to the same task, and have released a summary of their findings concerning the East Palestine, Ohio, rail accident. Congress would do well to implement their findings…
Tax
Because South Carolina wisely resisted total lockdown during Covid, coming out of the pandemic, we were in a good position. But on fiscal issues, state leaders had been content to kick the can down the road for far too long. Would they ever get around to addressing festering tax-policy problems?…
By today promising to keep Joe Biden’s pledge not to raise taxes on people making less than $400,000 (that’s 98 percent of taxpayers), Kamala Harris has also, whether she realized it or not, promised to extend the individual provisions of the Tax Cuts and Jobs Act, the law Trump signed in 2017, for nearly all taxpayers…
The Harris campaign is trying to make it sound as if Vance was calling for some kind of dystopian makeover of tax policy. But he wasn’t. U.S. tax policy, in 2021 and right now, effectively has a higher tax rate on childless people than on people with children. That’s because of the child tax credit, which is quite popular, and politicians from both parties have voted for it in the past…
Labor
Seven major U.S. labor unions have issued a joint letter urging President Biden to immediately stop all military aid to Israel. “Mr. President, the time to act decisively to end this war is now. Stopping U.S. military aid to Israel is the quickest and most sure way to do so, it is what U.S. law demands, and it will show your commitment to securing a lasting peace in the region,” the letter reads…
Medicaid
New York governor Kathy Hochul told Bloomberg that the state’s Medicaid program is being abused to the point that it accounts for most of the increase in jobs in New York City over the past year…
Education
Aaron Garth Smith & Christian Barnard:
Since the start of the pandemic in 2020, public schools have been flush with cash despite losing 1.2 million students. Between 2020 and 2022, inflation-adjusted funding per student increased in 47 states. In addition to $190 billion in federal Covid aid, public schools have benefited from state policies that end up funding students they no longer serve…
UBI
What’s the impact on employment of giving a large amount of cash to people unconditionally? A new study by Eva Vivalt, Elizabeth Rhodes, Alexander W. Bartik, David E. Broockman, and Sarah Miller looks at this question…
Over at AEI, Kevin Corinth comments on the new UBI study I mentioned on Monday
Climate
[R]reading this article in the Scientific American by Jules Boykoff, made me look at the Olympics with, if not exactly affection, a certain amusement. It turns out that despite the organizers’ promises of “sustainability,” despite the heroic (if ultimately unsuccessful) battle against air-conditioning, despite grim menus (less meat, more greens), despite “the seats in the aquatic center, which are constructed exclusively with local plastic waste”, and despite many such despites, when it comes to climate policy, the Games, like so much human activity, seem to be receiving a failing grade from climatists, made more stinging still by allegations of, inevitably, greenwashing…
The Olympic Games
The promoters of the Paris Olympics claimed that it would be budget-conscious. And, compared with recent extravaganzas, it has been, although that’s a low bar…
The Administrative State
In a new opinion, the United States Supreme Court ruled in favor of what most Americans have known for decades: Our government bureaucracy has grown too big and too powerful…
Rent Control
I wrote about President Biden’s proposal for a “temporary” and “limited” form of nationwide rent control in the most recent Capital Letter, suggesting that it presaged worse to come and that the signals it sent to prospective landlords, even if they were not covered by the rules being put forward by the administration, were likely to prove counterproductive.
One aspect of the proposal was that it was not to apply to landlords building new rental properties or carrying out substantial renovations. I doubted how much prospective landlords would be reassured by exceptions such as those…
Planning
“Funding is not enough,” Mazzucato claims. “What’s needed is governance of the process in the public interest.”
That may sound nice on paper. Just get a bunch of capable, well-intentioned people together to make life better for everyone. Unfortunately, it’s dead wrong…
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