June 18, 2024 - 10:00am
Argentina’s Javier Milei must have breathed a sigh of relief when he saw last week’s inflation data. It showed the first annualised decline since the President took a major gamble by allowing the peso to devalue late last year, with inflation falling from 292% in April to 276% in May.
While the country is still experiencing inflation levels that would be unthinkable in most countries, Milei’s supporters are taking this data as evidence that the economy is adjusting to the President’s reforms. But this interpretation is likely based on a misunderstanding of what is actually driving Argentina’s inflation. Milei and his supporters have convinced themselves that the culprit is too much government spending. He has engaged in aggressive cuts which have resulted in a government surplus. The problem, however, is that there is no evidence that government spending is driving inflation.
In 2022, for example, the Argentinian government posted a deficit of 2.4% of GDP. This deficit had fallen from the previous year, when it was 3.1% of GDP. In the same period, inflation rose from 38% at the start of 2021 to 95% at the end of 2022 — a decreasing government deficit was accompanied by rapidly increasing inflation.
More than this, however, Argentina’s government deficit is striking in that it is not very large. Compare the 2.4% deficit as a percentage of GDP in Argentina in 2022 to other countries in the same year: the United States (5.4%), the United Kingdom (5%), France (4.8%), and Spain (4.8%). These countries had much higher deficits than Argentina, yet none of them saw inflation spiralling to nearly 100%.
The true drivers of inflation in the South American country are twofold. First, Argentinians are so used to inflation that they index wages and prices to the current inflation rate. Having experienced high inflation for so long, they really have no choice in this respect. But it means that inflation tends to self-reinforce: as the rate rises, businesses and workers lock in price and wage increases which in turn generates more inflation.
Secondly, because of high inflation the peso tends to undergo periodic violent depreciations, which increase the price of imports and thereby trigger a bout of inflation that gets locked into the system through wage and price indexation. These dynamics explain why Argentina remains perpetually locked in an inflationary cycle.
The problem for Milei and his supporters is that another depreciation of the peso is on the cards. Last month, the currency’s unofficial or “black market” rate plunged against the dollar falling 15%. Currently, the government — going against its libertarian principles — is propping up the official rate. But this cannot last long. The ratings agency Fitch expects another devaluation by the end of the year. This will mean another sharp burst of inflation which may trigger an uncontrollable hyperinflation.
Milei was playing with fire when he devalued the peso late last year. He let the hyperinflationary genie out of the bottle in a way that makes it impossible to put back in. Now he is trapped between artificially propping up the currency — something he railed against as a candidate — and allowing a further depreciation of the peso and yet more inflation. The President is now being forced to realise that the simple solution to the country’s persistent inflation which he promised to voters is non-existent. There is no magical libertarian fairy who can cure Argentina’s deep structural problems.
If Milei fails, there will be serious consequences. A hyperinflationary collapse of the Argentinian economy will present the country with two choices: either approach the IMF for a bailout or, more worringly for the West, consider approaching China and the Brics alliance for assistance. Argentina has had rather dismal experiences with the IMF in the past and, should the pro-Western Milei be discredited, so too will the Western institutions of which he is so fond.
It seems perfectly plausible that if Milei fails, whoever succeeds him will approach the Brics nations. Western observers, pointing out that Milei pulled his country out of the Brics application process, hoped he would be the president to shift Argentina away from the Chinese-led grouping. A pro-Western ally was finally within touching distance after years of Peronist hostility. But the economic policies he has pursued may unwittingly drive the country further into the arms of the Brics nations, and away from Western influence.
Philip Pilkington is a macroeconomist and investment professional, and the author of The Reformation in Economics
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SubscribeThey maybe need to use a new currency like the renminbi until it all settles down and the system has stabilised but that would be too much of a climbdown for any national leader I suppose.
Milei wanted to dump the peso for the dollar.
The Renminbi is not convertible in capital account. Until China agrees to internationalise its currency, it won’t be a viable choice (which is why even the Hong Kong Dollar’s currency board is based on the US Dollar).
Wrong. The problems are solvable.
Argentina cracked inflation in the 1990s by pegging the peso to the US dollar (at a 1:1 ratio – you could spend dollars as easily as pesos in the country at the time). It’s been done before. Milei is simply trying to repeat what Carlos Menem did in the 1990s, but in a way that makes it stick this time.
Argentina indeed faces a critical choice. Take the severe short term pain and thrive as a vibrant Western economy. Or bail out and join the losers club called BRICS.
I’m baffled by anyone that truly believes in this nonsense “Western” promise. We in the West have been facing for decades now lowering standards of living and heavy democratic backsliding. We are living off our past, I don’t think we’re the future.
Nonsense.
The reason the West isn’t doing as well as it used to is because it’s abandoned many of its critical values that made it so successful. Not because it has the wrong core values. We’ve drifted off course. But we’re heading in the right direction.
But meanwhile – in spite of all this – the US has the lion’s share of the world’s fastest growing and most profitable industries. China, on the other hand, is growing at the low end of the value chain.
Check also the thriving economies of Asia who largely succeeded because they adopted Western values better than the countires that developed them.
Finally, ask yourself just why so many people continue to queue up – legally and illegally – to move to the US. Who’s queueing up to move to Russia or China ?
Er, perhaps because the West welcomes vast quantities of unskilled migrants pouring into its societies – and radically transforming them in the process, and other more sensible politics do not!
We have “drifted off course” but “we are heading in the right direction” are two contradictory statements!. I agree we have gone off course, but there is absolutely no sign that the West is now correcting it in a sensible fashion. Rather it is doubling down stubbornly on the very policies, “Net Zero” and mass unskilled migration and the dissemination of woke ideology most obviously – that have been so disastrous.
Having technological superiority – which is in any case very questionable in future as the US fears itself – is not everything. Firstly much of this economy does not benefit ordinary people. Secondly, I seem to recall a ragtag bunch of guerrillas defeating the US both in Afghanistan as of course earlier in Vietnam. The US has almost no chance whatsoever of defending successfully Taiwan at a reasonable price it was willing to pay.
New peso, Argentinian dollar or something like this.
Argentina needs something like the 1990’s Brazilian “Plano Real”, which established a new currency and curbed hyperinflation. Neither libertarianism, and neither the West or China will do what needs to be done.
Inflation is always and everywhere a monetary phenomenon. If you ration the number of new pesos, it becomes more and more difficut to find the pesos to pay for higher prices, so inflation must slow or consumption must fall, and falling consumption will also eventually slow price rises.
There is a loophole in this monetarist logic: dollarisation of the economy. If more and more pesos are converted to dollars for transactions, then more and more pesos become available irrespective of the supply (or not) of new pesos by the government and central bank. Naturally, this constant selling of pesos for dollars makes for a serious imbalance in supply versus demand and self-corrects by periodic peso devaluation versus the dollar.
By pegging the peso to the dollar, converting pesos to dollars is effectively rationed, and this would traditionally close the monetarist loophole. However, Argentina has well-developed, large unofficial exchanges. As a result, today Argentina holds nearly 10% of all dollars in circulation, representing about 50% of the Argentine economy. Argentina’s government cannot stem dollarisation by pegging the peso so the monetarist loophole remains wide open.
There is though a limit to dollarisation: the Argentinian state’s demand for pesos. All government workers are paid in pesos, and all taxes must be paid in pesos. The question then is this: how much effort will people and businesses go to to reduce their tax bill? The less tax evasion and avoidance there is, the slower the rate of dollarisation.
Presently Argentina suffers from very high levels of offshore tax evasion and avoidance as you’d expect from an economy where so many transactions take place in dollars. Lower taxes will reduce tax evasion and avoidance, slow dollarisation, lower the supply of pesos, weaken demand for dollars, and stengthen the peso. Ironically, for the short term at least, a wider government deficit – if spent on significant tax cuts – could slow the rate of dollarisation and lower inflation.
The bind for Milei is a larger public deficit needs balancing by internal demand for government bonds – not a foreign debt infusion nor money printing by the central bank otherwise the deficit will worsen inflation in the medium term as it has done before. But Argentinians have little appetite for saving pesos in govermnent bonds so Milei has no option but to further cut public spending to keep the deficit manageable.
Neither the BRICS nor the West can fix Argentina’s peso inflation problem with financial assistance and bailouts. Only Argentinians, the individual and macro decisions they make, can alter the peso’s monetary trends. Milei has half a solution. The other half is the confidence of Argentinians to change hard-wired behaviours when it comes to managing their pesos. More bland technocratic managerialism won’t shift public perception, but wild-haired radicalism might.
Excellent information here. You’ve added some important information to this discussion so kudos to you. One of the problems of globalism is that it’s become impossible for the national governments of nations to exercise sovereignty over their economies because any action a government takes can be erased by the actions of other nations, private citizens, or some combination of the two acting together purposefully or coincidentally. Stated another way, the old school monetarist wisdom worked pretty well back when national economies were mostly closed systems where most interactions were between actors within the national economy and transacted in the national currency. Now, though, there are no closed systems. National currencies are exchanged freely against one another with little regulation or input from national governments, and of course there is no international body with any real authority to act as a mediator of disputes. As a result, any action a government chooses to take can be undermined by the actions of an international rival for the purpose of geopolitical advantage and/or by the actions of its wealthiest citizens who are likely to act in their own self-interests regardless of whether this aids or hinders intended government policy.
Argentina’s problems, while unique in their individual character, are not unique as to their cause. Almost every nation is feeling the conflict between the interests of its citizens and impersonal economic factors. The legitimate responsibilities of a government to protect and defend its citizens are running up against the demands of a global economy that has become an independent beast of its own. It’s difficult to assign blame definitively. Many have benefited from globalism while others have suffered and usually not by anyone’s overt design, although the political and economic elites of the USA stand out as at the front of the line in terms of disproportionately benefiting from the scheme. This is basically where we are and the source of much if not most of our collective discontent at the national and international level. Given the impossibility of a fair and representative global government, it falls to sovereign nations to begin untangling the Gordian knot of international economic interactions, restoring national sovereignty, and re-establishing some level of popular economic self-determination through the acts of government and the choice of elected leaders and parties. Milei, like Meloni, and Wilders, and many others, will ultimately be judged by history on his handling of this herculean task.
Monetarism was abandoned in the UK under the Thatcher government. It’s a simplistic theory
Whether he can tackle inflation or not he has reduced the parasitic government class. That is good for the spirit of a nation.
Why will Argentinas inflation force the country into the arms of BRICS?
I know Pilkington loves to talk up opponents of the west at every opportunity but what will Russia and South Africa do to help Argentina combat inflation? He never bothers to explain
Argentina needs to consider a total default on all debts public and private. Completely reboot the economy. Things may clear up after a formal national bankruptcy.
So, is Pilkington a paid China agent, or a volunteer?