Two to Tango: your savings but my expenditures; and the re-coupling of the financial channel—or: the Tango Effect Returns?

The following post appeared in RGE- Monitor (Latin America) on October 23rd, 2008.

Argentina’s (government) is decoupled (of common sense): when there was a global expansion in commodities (the so-called tailwind) the administration pump up aggregate demand (with inflationary effects and resource misallocations). Now, as the global economy slowdowns sharply, affecting U.S., Asia, Europe and Brazil (Argentina’s main trading partner); not only commodities’ prices, but also external demand decreases. Thus, the trade channel was expected to be the main source of the negative shock—after all, Argentina had almost no access to international financial markets (not only due the 2001 default but also due to policy applied since then). But Fernandez de Kirchner is causing the financial channel to re-couple. While the world economy is progressively trying to stabilize in baby steps, Argentina’s government plants the seeds of its own destabilization. The Tango effect might be approaching: debt default? (the country risk is close to 2000 pts.), the government almost repudiating its obligations, unemployment and volatility with upside risks, output with downside risks (all of which point to even lower than expected revenues in the near future and the medium run), increase in demand for dollar deposits—the Central Bank probably losing international reserves in the process. Will the exchange rate be devalued? My sense is not whether the domestic currency will depreciate or not, but at what pace. It seems that the central bank intends the depreciation to be progressive, gradual. But, will that be possible?

Is always easier to blame “the marketplace and the neoliberal policies;” or is that the current administration is in a way forcing market forces to act—it is always simpler to blame it for your mistakes…

It is worth mentioning that government debt is still highly dollarized, while revenues—in domestic currency—will tend to decrease, and funding is already extremely limited and poised to freeze, the more so with the socialization of pensions with a decreasing revenue to finance the PAYG social security system.

How will this end? I leave to the smart reader to answer this quite obvious question.

Is Argentina running out of funds?

The following post appeared in RGE- Monitor (Latin America) on October 20th, 2008.

The Argentine government is, apparently, in the process of reabsorbing the retirement and pension system privatized in the 1990s’. The official argument, of course, is the international financial crisis. (Wasn’t Argentina de-coupled, and totally resilient to the crisis, as per the authorities?). I would interpret it differently, though. The government seems unable to rein in public expenditures. In turn, this is worsened by 2009 being an election year in the context of an economy that slowdowns markedly (and mainly due to internal wrong macro-management much more than and prior to the external shock), and very limited financial access—I have elaborated extensively on these topics in previous posts and the use of temporary high tax revenues to finance quasi-permanent expenditures. You can also add a presidential image that plummeted through 2008. Thus, the government is desperate to obtain funds to increase expenditures, which are quite scarce for Argentina.

Some commentators argue that the external shock calls for a fiscal response to smooth the business cycle—that should not exist in the first place as per the previous calculations of the government regarding the international shock. Isn’t the U.S. doing it? But Argentina is not the U.S. Clearly, its default history differs substantially, as well as respect for property rights; and the list follows on and on. Only when a country’s reputation is high enough is that economy able to step in to temporarily buy equity in firms to stabilize a crisis. This does not apply to Argentina’s current administration.

But this is not new. The Kirchners ‘administration have made use of this “tricks” more than once—and so did Peron. In the name of retired people’s benefits—not true, though—the administration is able to obtain current funds that otherwise will be unable to borrow. The intertemporal magnitude of this is not trivial: by acquiring the present flow of funds to finance current (but potentially quasi-permanent) expenditures, the federal government also incurs in present and, more importantly, future liabilities (mainly not taken into account)—not to mention the efficiency losses derived from “governmental” managers not usually chosen due to their technical ability. Will this affect the future ability to roll-over debt? This is still an open question. No wonder that Argentina’s country-risk increased—and might keep on increasing. Furthermore, the short run impact of this affect the banking system—probably the only sector with some resilience of the crisis, since the real sector will be strongly affected.

Add to the latter that the government wants to exchange its debt—so as to transfer over time the burden of capital repayment—would you like to be in charge in 2011? I wonder if someone will…

Finally, let me comment on the response of the current administration to the international financial crisis. The idea seems to be to increase public expenditures (as mentioned above), closing the economy and potentially gradually depreciating the exchange rate. Closing the economy is not the right answer. The adjustment of the exchange rate would have been correct, provided that the past macroeconomic policy had been responsible—the latter not being true. Had Argentina respected property rights, not manipulated inflation and other official data, pumping up the economy to increase inflation, stimulated investment (instead of only consumption) and productivity, etc, the answer would have been different. But now, however, there is higher probability that changes in the exchange rate will be transferred to prices—nobody will be surprised why this did not happen in Brazil or Chile, right? The administration preferred not to slow down the economy to control the inflation rate when things were manageable. May be it is time to start paying the bills (sooner rather later).