I am going to confess an unpopular opinion: I am getting worried about Argentina.
I am also going to confess to embarrassing naivety: I have been testing my hypothesis with the wrong bankers.
But first, my concerns about Argentina. The mess up in monetary policy at the end of last year and the beginning of this one saw a delicate communications challenge around the changes to the central bank’s targets trampled on by the clumsy and damaging decision to accompany this policy change with two 75 basis point cuts to interest rates.
The central bank was beginning to get some traction in its very difficult and long job of bringing inflation down in a country that is synonymous with the phrase ‘unanchored expectations’.
As night follows day, inflation – and expectations of future inflation – have turned reversed and are now rising. At the very least, the authorities have wasted precious time in getting inflation down to levels where the private sector sees exchange rates and interest rates at stable levels – where investments make financial sense.
Credibility, as the maxim goes, is hard to win and easy to lose. Argentina just lost a big chunk of credibility.
There are persistent rumours at home and abroad that the mistake was the result of a fight between economy minister Nicolás Dujovne, who wanted to provide some monetary relief in a bid to drive economic growth above 3%, and the central bank governor Federico Sturzenegger.
If true, the loser wasn’t really Sturzenegger, it was Dujovne’s economy and the country’s population that must, soon enough, restart its painful fight against inflation. Because how can you lower inflation without hiking interest rates? Where’s a case study economy that managed to lower persistent double-digit inflation at the same time as increasing GDP growth? If there is one, I’d love to see it.
Just a cursory look across Argentina’s border to Brazil shows that there are no short cuts. There, the central bank increased interest rates, pushing a slowing economy into a deep recession. Pain followed – most notably high unemployment. But the central bank sat on those high interest rates until inflation collapsed. That is what Argentina needed – and needs – to do. You can’t get back on the path of reform that they were on.
Contrarians might argue that president Mauricio Macri’s economic model requires 3% growth to boost government revenues to finance and make possible the gradual fiscal adjustment. In turn, that fiscal adjustment will help monetary policy, which was doing most of the work (and capping growth). Also, this model needs a stable exchange rate to give stability for foreign investment and to help with inflation. But of all these interacting forces inflation is the most important. Without low and controlled inflation, you cannot achieve a stable currency.
So, recently I have been asking senior bankers about their views on the potential importance of Argentina’s monetary misstep. To me, it seemed like a genuinely big mistake and one that makes an already perilously narrow path to orthodoxy razor thin. Wouldn’t resurgent inflation delay investment? Without GDP growth of 3% – and it is still below this crucial level – isn’t there a risk of dangerous fiscal imbalance? And for how long can they finance this fiscal shortfall in foreign currency? If investors lose patience – maybe they start to fear repayment problems, should the Argentine peso collapse and leave their large dollar external debt commitments exposed – what happens to the currency? And then inflation? And then what, ultimately?
But the bankers all say that they can’t see this ending badly. And that’s when my naivety hit me – I had been speaking almost exclusively to capital markets bankers and economists. The latter are usually centrists and consensualists, and the former are making so much money from selling Argentine debt to international investors that they don’t want to see any problems. And even if they do, they certainly won’t articulate them to the press, on or off the record. This gravy train could still have years to run. A recent phrase used by Paul Krugman about the US Republican party, “motivated gullibility”, came to mind.
But talk to traders, and the conversation has a starker quality. ‘No way out’ Like me, some can’t see a way that Argentina can finesse its way out of this. Interest rates will have to go up again – and stay up until they actually manage to get inflation on a sustainably downward trajectory. That will mean economic slowdown, if not recession. So the fiscal adjustment will need to be sped up or risk fiscal collapse and an unsustainable debt build-up – with a large proportion in foreign currency.
The other way in emerging markets history has been to inflate your way out of the problem through a weaker currency, but that means a swift end to Macri’s attempt to cast the Argentine economy in a new economically orthodox light. The working assumption must be an increase in rates and that the government will switch its priorities to reflect the supremacy of the inflation fight over growth.
As one FX trader told me: “You can’t get back on the path of reform that they were on. Argentina is now on a permanently worse trajectory than it was before. The inflation leg of the ‘trilemma’ is the most important. Eventually they will have to raise interest rates to tame inflation via the currency, and everything else – the growth rate – will be sacrificed.”
Read all this together and there is little chance that the Argentine peso will appreciate on spot in the longer term. But the downside to talking to traders is that their timeframes are much, much shorter than mine.
When I asked what our shared view of peril for Argentina meant to him strategically, he shrugged: “At the moment, the central bank is supporting the Argie, so tactically it’s a buy.”