Pro-cyclical government expenditures and commodities’ prices in Latin America (and Argentina in particular)

The following post appeared in RGE-Monitor (Latin America) on September 8th, 2008.

The pro-cyclicality of Latin American fiscal policy has been extensively documented (see e.g., Kaminsky, Reinart, and Vegh (2004), Talvi and Vegh (2005), Hausmann and Gavin (1997) among many others). The recent boom in commodities’ prices that started in the early 2000’s add one additional set of observations to extend this literature, albeit with some important differences.

Some countries internalized the temporariness of the boom in commodities’ prices and fiscal expenditures were increased accordingly. One example of the latter could be Chile, where what can be computed as the permanent component of the terms of trade shock can be spent while the transitory component has to be saved for the long-term purposes.[1] In a way, another case can be made of Brazil were the government stimulates investment in the agricultural sector to take advantage of this boom such that that the country can obtain long run benefits of this temporary boom. The list does not end here.

However, other countries did exactly the opposite: spend permanently based on this transitory shock. Argentina, unfortunately, fits this case. Government expenditures have been increasing at very high rates—higher than GDP. Granted, tax revenues also increased substantially—the economy emerging out of one of the worse crises in its history jointly with the international boom in commodities’ prices and an increasing inflation, though (i.e., based on temporary sources).

Commodities’ prices have been (as expected) progressively reverting down—a correction to their long-run level—and this could be expected to continue. At the same time, international financial turbulence started over a year back and it is still not done. During this time period, as mentioned above, Argentina has been engaged in a spending spree that has accelerated, among other things, due to subsidizing consumption as the “anti-inflationary” strategy—along with price controls. It is not the purpose of this piece to elaborate on the causes of this explosion in government expenditures; although the main reasons seem to be political objectives matched with some misunderstanding of (short-term vs. long-term) macroeconomic management.

It’s worth mentioning that (only) some current measures seem to go into the correct. However, will that be enough? That still needs to be seen. So far, the measures look more like stray signals rather than a true and deep change in the macroeconomic policy. This is not without a cost, though. Even if the government engages in the required long term corrections, given the delay already observed, regressive income distributions could happen. History has a lot of observations that show how populist government expenditures pro-cyclicality end.

Given the observed response of government expenditures to these external shocks, some yellow lights are:

1. Fiscal fragility (and capital account?) likely to worsen. Expenditures: Will government expenditures be reign in? Actually, it looks like the opposite—as per the 2009 fiscal budget act project. The government is looking for alternative instruments to finance higher expenditures—like enabling the currently forbidden lending from the Banco Nacion (the major national public bank, where the government deposits its money), but not reducing them. The latter resembles, in some aspects, the old-fashioned (central bank’s) quasi-fiscal deficit which tends to worsen inflationary situations. Some cosmetic accounting has been used to try to show a fiscal surplus that is not really as strong as claimed (central bank transfers plus arrears)—so now even the flow balance is becoming fragile—not to mention the intertemporal stock. On the revenue front, if commodities’ prices keep on correcting and the real exchange rate appreciating (domestic inflation plus an appreciating dollar as commodities revert to long-run trend) they would tend to decrease. And what if the current account moves to a deficit (chances now increasing)? What will happen with the quasi-fixed exchange rate? Will the so-called “exchange scarcity problem” reappear?

2. Financing problems. High interest rate: lack of international lending to Argentina; that’s why the administration decided to repay to the Paris Club (in cash though, instead of through the IMF, as would have been wiser). Showing this willingness to pay is good news but not enough and probably with less impact on the country’s credit constraints than truly putting the macroeconomic policy in a sustainable path. Let’s notice that even though the repayment might (marginally) reduce the interest rate, this effect favors investment projects. Without correcting the whole macroeconomic policy-frame investments are unlikely to be many anyway. That means spending almost 15% of international reserves (close to $7,000 out of $47,000) for probably not much future return—losing reserves when the world economy will probably provide less foreign exchange to Argentina as commodities’ price decrease and the world economy slows down—increasing the chances of systemic risk. Worse, the only “benefits” would be more expansionary aggregate demand (not surprising given elections next year). The latter, jointly with any interest rate reduction will clearly not contribute to control the high domestic inflation.

3. Inflation. Domestic inflation has substantially separated from world inflation. However, so far the government seems to lack an inflation stabilization plan—other than stabilizing at the already high levels, which depresses long-term growth.

4. World economy slowdown. The U.S. seems to be headed to slower growth—in the brink of recession. Europe and Japan do not look much better. This is likely to affect Asia since the latter’s exports are mainly driven to developed countries. As a collateral effect I can not discard some effects on Brazil, a huge trade partner to Argentina which, by the way, has done the right job by tending to cool its economy to keep inflation under control. This is not without recessionary impact, as should be; thus, all else equal this would contribute to worsen Argentina’s external balance.

Notice that all of the above, among other things, involve a strong control of government expenditures as (part of) a corrective device. Reduced public spending not only increases the present fiscal balance, but also improves its future stance. It ameliorates the government financing pressures, contributes to control the inflation rate by reducing aggregate demand at the same time that frees up financing resources (and reduces interest rates) for the private sector—the old-fashioned “crowding-out” effect—and tends to depreciate the real exchange rate, thus helping the exporting sector.

All in all, it seems that Argentina needs a comprehensive macroeconomic reform to wisely take advantage of the commodities boom windfall, and stop always being behind the curve. The problem is that this external shock is currently slowing-down for good. So far, the country has only benefited from the boom’s short run externalities, discounting the long-term effects as second order. The above points just signal the lack of this type of strategy, and implies that not only has Argentina not paid much attention to the (infrequent) opportunity that the world economy has provided to catch up with the developed world—it has almost nullified its long-run positive effect. This seems to be a positive externality. However, Argentina is responding with a negative strategic complementarity…

Notice that since debt obligations involve a temporal links, fiscal policy is extremely important. Not only past and present fiscal policy matters (reflected in (1) above), but also the future effects of current fiscal policy ((1), (2), and (3)), as well as the current expectations on future fiscal policy ((1), (2), (3), and (4)). Let’s add that 2009 is an election year and the administration since 2003 has pursued aggressive fiscal expansions during election times. The more so for a politically weak government (i.e. a government with a low political capital) that does not internalize the amplification and propagation of its own policies and the world economy’s shocks into the future of the country’s volatility and growth.

On a positive note we can argue that for this to end on an economic crisis we need to observe some events with joint probabilities that are difficult to happen. On a negative note, however, although difficult, these joint probabilities seem not impossible—and the government contributes to make them more likely.

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[1] See Izquierdo, Talvi .and Ottonello (2008) for details.

Is (the Kirchners’ self-inflicted) Potential Hyperinflation Possible (Again) in Argentina?

The following appeared in RGE Monitor (Latin America) on August 1, 2008.

This is a valid question to ask ourselves, as the Kirchners’ administration has consistently pursued populist economic policies that usually end in a hyperinflation episode. This becomes more relevant if we review the economic history of the country. Once and again we have seen a sequence of events, many of which we have been observing during the past years, that ended badly. A short list follows.

- Wage increases not only increase in frequency, but also in magnitude: during the last agreement (late July) minimum wage increase was in order of 27%—after having been raised closed to 20% in H1.

- Tax revenue is mainly driven by the inflation tax (e.g. VAT) and the external boom (export taxes); the latter not being permanent.

- Government expenditures increase at very high rates (in the 40% area). The government so far has been unable or unwilling to rein it in.

- Given the already high inflation that has been partially and regressively repressed by subsidies, the government is now starting to let some of the “freezed” prices to partially accommodate. This is welcome; but too late. Notice that so far it only intends not to increase subsidies, but not reduce them.

- The so-called fiscal surplus is under big dispute. Its present stance is probably worse than officially argued (as many private sector reports show). The future balance looks much worse.

- Consumption-driven economy—as opposed to investment-driven. This is not trivial. Increases in present aggregate demand derived from investment create the ability to increase future aggregate supply in line with higher aggregate demand. Consumption-driven impulses do not necessarily create an investment stimulus; especially under weak property right—where every profit looks like “extraordinary profits” and thus “taxable to redistribute income”. Of course this ignores the regressive income distribution—present and future—that high inflation causes.

- Tardy (i.e. now that the current stance and especially the future outlook start to look gloomy) increases in retirement benefits. The main motive for this being increase aggregate demand while gaining some political support after the failure in the (export-tax) confrontation with the agricultural sector—as retired people tend to have a relatively high marginal propensity to spend. It is worth mentioning that the conflict with the agricultural sector is far from over, as the government still has plans to re-instate this export taxes, albeit in a different way—the administration needs the cash.

- Price controls to (supposedly and ineffectively) control the inflation rate. This distorts relative prices and potentially triggers repressed inflation. If the latter holds, the relative price correction is rarely swift… And I can’t call this an anti-inflationary plan.

- Annual inflation expectations close to 35%. This seems to be in line with the private sector inflation estimates for the moths to come. The more so if with the price realignment mentioned above is considered.

- Families are highly indebted and the delinquency rate is increasing.

- The real exchange rate has been continuously appreciating as the inflation rate is on the rise while the central bank, in a way, targets the nominal exchange rate.

- Political unrest: not only the President-Vice President recent controversy, but the social unrest in the interior (e.g. Cordoba, Santa Fe, etc.), and, consequently, a politically weakened government—its own alliances melting down due to the policies applied by the presidential couple during the last years.

- History tell us that too frequently in the past Argentina raised wages, utilities, etc., and let some of the relative prices to re-accommodate as a pre-stage to a devaluation (with lots creativity such as splitting the foreign exchange market, fixing the exchange rate, interest rate caps, etc., and an infinite list).

- Luckily the economy has not demonetized (yet?) and the central bank has not depreciated the domestic currency (yet?); as this will probably make the system to explode. But, as a signal, the “founding fathers (both ideologists and implementers)” of this so-called “productive model” are already fleeing away, trying to decouple themselves from it

So, hyperinflation is not a problem in Argentina for the moment. However, I could change this to may be not yet, since unfortunately we cannot disregard it in the future. Unless I assume that the government is intentionally stimulating inflation to reduce (i.e. inflate away) its real expenditures instead of reducing its expenses. If so, somebody would need to remind the authorities of the Olivera-Tanzi effect—and that this basically does not work. This would be totally erroneous since—although worsening as a consequence of its own external tax policy—the surplus in the trade balance is still positive. Things can get really nasty is this surplus disappears…

There is still (little) time to correct this. But among the features that should be included is a strong fiscal correction, freer markets (including relative prices!), better property rights, an independent central bank, a long-term growth strategy (that includes investment incentives along with lower inflation—the latter resulting from a serious anti-inflationary program). However, and against my wishful thinking, next year is an election year. The government has already lost a lot political support, so it could easily be tempted into reinforce the (already failed) populist policies. The more so since the policies that would help recover long-term and stable growth usually take time so enact—probably not enough time until the next election.

Macroeconomic Dynamics and (Present and Future) Income Distribution in Argentina: a Lucas’ Critique View

This post appeared on RGE-Monitor (Latin America) on July 21, 2008.

The export tax law that Argentina’s president submitted to Congress ended as a complete failure for the current administration—the more so since it was finally rejected by the negative vote of the vice-president. However, I look at the episode as the best outcome possible for the current administration. It actually gave the government the ability to start afresh. The vice-president rejection actually enabled the president to obtain an elegant way out of an economic mistake—with potential social unrest. Will the president take advantage of this? Although I truly hope that “words” will actually be contradicted by “facts”, as of today I am inclined to think the answer is not—details follow.

As per the information available it seems that in order to re-boost the high inflation-low growth direction that the economy is taking the government is planning to increase the after-tax wage of middle-income families—and, at the same time, to try to partially re-gain some political support (currently close to 20%). Supposedly, the government intends to provide a fiscal stimulus: increasing the gross income level at which employees start paying income taxes, increasing net wages. That would not surprise any economist if the economy is slowing down to below full-employment. But this is not the case of Argentina. This looks even worse once we factor in an inflation rate in the 30-35% range.

On the contrary, such a policy will more likely end up being the worst of all medicines—potentially killing the patient. For, this will accelerate the (already high) inflation rate, as middle-income people consume more—but firms are unlikely to increase employment. The more so since this policy will probably trigger distributional tensions, as unions will press for further, more frequent, and greater wage increases.

Why do I think that this fiscal stimulus will exacerbate the inflationary pressures? Among many other reasons, I can mention: inflation expectations could jump, aggregate demand could increase due to consumption increasing (but not because of investments as high inflation and interest rates, plus uncertain exchange rate market and property rights call for firms’ caution), and the worsening of the present and future fiscal position. Add to this a global slowdown, more stringent international credit markets (the more so for Argentina), and the fact that the current administration is financing present expenditures that become permanent with transitorily high revenues.

On the latter, we can not only consider the lower real revenue (inflation can compensate partly, but not when demand is going down at an increasing rate), but more importantly this will accelerate the already huge bill that subsidies to the middle- and higher-income represent. And most of these subsidies (energy, gas, public transportation, etc.) benefit relatively more to relatively higher income people—thus it represents a transfer from poor to rich people. It has been suggested that some of these subsidies will be reduced by letting prices increase. This would be great news—if enacted. For, some couple of months ago some of the previously “frozen” prices were permitted to increase a little bit. However, and contrary to what was stated by the authorities at the time, subsidies were not reduced at the time—they actually kept on increasing.

So all in all, this represents a current transfer of resources from poor to reach people. But, it represents a much higher future transfer in the same direction. Eventually the economy will need to be aligned back to trend. This will require a drastic adjustment in government expenditures, interest rate hikes, (real wages contractions?) and, in general, a strong contraction of the economy to correct all the accumulated and increasing resource misallocation and misaligned relative prices (and the exchange rate…?). And the adjustment will need to be greater the longer it takes to be internalized.

Therefore, what I observe is a variety of the classical Lucas Critique problem. The government is planning (again) to pump up (private consumption) domestic aggregate demand not realizing the future effects of these policies. By not internalizing the present and future impact of its own present public policy—thus lacking any medium and long term strategy—it might lose another chance; in this case shifting from economic instability to political instability. Unless they want the political instability to emerge—so as not be made responsible for its own mistakes.

And the worst of all these consequences it the present and future income redistribution (from poor to rich) that this supposedly “popular” (I would say “populist”) administration is generating will do nothing but worsening even more the standards of living of those in the lower income brackets.

Hopefully the available information is wrong and the president figured out that the rejection in the senate has turned into her best chance to achieve the best for the country. We’ll see.

On Populism in Argentina (and other Latin American Countries)

This post appeared in RGE-Monitor (Latin America) on June 25, 2008.

I came across this piece on populism so I decided to share parts of it with you.

“… [E]conomic populism is an approach to economics that emphasizes growth and income redistribution and deemphasizes the risk of inflation and deficit finance, external constraints, and the reaction of economic agents to aggressive non market policies… populist economics ultimately fail; and when they fail it is at a frightening costs to the very groups that were supposed to be favored.

Features:

1. Initial conditions. The populist policymaker—and the population at large—are deeply dissatisfied with the economy’s performance; there is a strong feeling that things can be better. Typically, the country has experienced very moderate growth, stagnation, or outright depression as a result of previous stabilization attempts. This previous stabilization experience often, though not necessarily always, has been implemented under an IMF program and has resulted in reduced growth and lower living standards… The preceding stabilization would generally have improved the budget and external balance (through the accumulation of international reserves) sufficiently to provide the room for, though perhaps not the wisdom of, a highly expansionary program.

2. No constraints. Policy makers explicitly reject the conservative paradigm and ignore the existence of any type of constraints on macroeconomic policy. Idle capacity is seen as providing the leeway for expansion… The risks of deficit finance emphasized in traditional thinking are portrayed as exaggerated or all altogether unfounded. According to populist policymakers, expansion is not inflationary (if there is no devaluation) because spare capacity and decreasing long-run costs contain cost pressures and there is always room to squeeze profit margins by price controls.

3. Policy prescriptions. In light of the initial conditions described above, the populist programs emphasize three elements: reactivation, redistribution of income, and restructuring the economy. The common thread here is “reactivation with redistribution.” The policy recommendation is to actively use macroeconomic policy to redistribute income, typically by large real-wage increases that are not to be passed on into higher prices.

The Phases of Populist Economics

I. The policymakers are fully vindicated in their diagnosis and prescription: growth of output, real wages, and employment are high, and the macroeconomic policies are nothing short of successful.

II. The economy runs into bottlenecks, partly as a result of a strong expansion in demand for domestic goods… Whereas inventory decumulation was an essential feature of the first phase, the low levels of inventories and inventory building are now a source of problems. Price realignments and devaluation, exchange controls, or protection becomes necessary. Inflation increases significantly, but wages keep up. The budget deficit worsens tremendously as a result of pervasive subsidies on wage goods…

III. Pervasive shortages, extreme acceleration of inflation,… lead to capital flight and demonetization of the economy. The budget deteriorates violently because of steep decline in tax collection and increasing subsidy costs. The government attempts to stabilize by cutting subsidies and by a real depreciation. Real wages fall massively, and policies become unstable. It becomes clear that the government is in a desperate situation.

IV. Orthodox stabilization takes over under a new government. More often than not, an IMF program will be enacted; and when everything is said and done, the real wage will have declined massively, to a level significantly lower than when the whole episode began. Moreover, that decline will be very persistent, because the politics and economics of the experience will have depressed investment and capital flight.”

I can personally not agree more with the piece. It is astonishingly actual.[1] If somebody were to write this now, the description of the present situation in Argentina (and some other Latin American countries) can hardly be more accurate. The sad part of it is that this has been taken from a book printed in 1991[2] and based on the Latin American experiences of the 1950s-1980s! So we should have learned from our past mistakes instead of falling once and again on the same errors.

In the current Argentine case it seems that the country is between Phase III and Phase IV, so we should really be worrying. It seems pretty clear that the Kirchners’ administration were able to read the “Features,”… but not the “Phases.”

This has been just a historical piece. But, the question is: Will history repeat itself?

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[1] For further details, some of my past posts elaborate on the present policy problems, including the unsustainability of the fiscal balance, the acceleration of the inflation rate, the pervasive income redistribution, among other things.

[2] “The Macroeconomics of Populism in Latin America,” by R. Dornbusch and S. Edwards, NBER, The University of Chicago Press, 1991.

Sub-prime Crisis: Argentina’s Consumption-Credit Variety

This post appeared on RGE-Monitor (Latin America) on May 28th, 2008.

Global growth during the last five years provided a huge tailwind for agricultural producing countries boosting Argentina’s emergence of one of its biggest crises ever. The government response to this (temporary) windfall in its terms of trade and globalization not seen since the late 1800’s has been to stimulate consumption, instead of investment to capitalize the positive shock for its long-term growth. This can be observed, among many other things, by the huge consumption-credit boom of 2003-2008 (housing credit is relatively small in Argentina), especially to middle- and lower-income families. The domestically generated inflation has exacerbated the extensive use of this form of credit in a potentially unsustainable way.

Inflation, if temporary, can be expected to increase the use of this type of credit. Precisely this is the rational use of credit markets: to finance temporary shocks in order to smooth consumption. However, this is not the appropriate channel for permanent shocks as the current inflation rate, which is not expected to go away any time soon. When inflation starts to accelerate and being incorporated to inflation expectations and the government lacks a serious anti-inflationary program, and real wages start to decline, consumption is likely to lose pace. In this context, it should be expected that lower-income families in countries in which the share of food and basic stuff is non-trivial to being unable to meet all the required payments—the more so the higher the inflation rate—and for such repayments to be put on hold.

Paralleling the home-oriented sub-prime crisis in the U.S. where many credits where extended without the appropriate credit revision, many consumption-loans have been extended in Argentina. Although the amounts involved are lower, the collateral is worse: there is no home to be absorbed by the financial institution in case of default. And many credits were issued not only to buy cars or refrigerators, but also to buy clothes. Recent data from the central bank shows a substantial increase in delinquency rates in these types of credit, which doubled. Recent studies expect the delinquency rate to increase due to higher inflation.

A big share of these lending has been directly extended by stores selling these goods and financial institutions. These credits are then pooled and these financial instruments are then sold in financial markets—the so called financial fiduciary funds—which are supposed to hedge upon risk. As of now, middle and low income families are, on average, indebted on 80% of the monthly household income—for higher incomes this reaches five times the monthly income!).

Although the scale is much smaller, any resemblance to the U.S.? The rest is let for the smart reader to figure out.

Argentina: Some facts and some thoughts

The following post appeared in RGE-Monitor (Latin America) on May 9th, 2008.

Some (common knowledge) facts
- The inflation rate keeps on accelerating—there are suggestions that unions are seeking to renegotiate in H2 the ex-ante annual wage increases arranged around March (of this year!).

- Government bonds are being consistently rejected, their price decreasing; they would have fallen more if it weren’t for public institutions (e.g. public banks) aggressively purchasing them.

- Country-risk has increased.

- S&P put Argentina’s debt in “negative”.

- Government mismanagement, as expected, pushed the farm sector back into strike mode. This time, and to try to avoid food scarcity in cities, the farm sector will stop export products.

- The effect of the latter: reduced tax (export) revenues; if it also implies a reduction if expenditures (likely), it will imply a multiplier-type of effect in economic activity and thus overall tax collection.

- Argentina’s expected growth rate has already been reduced—and this does not take into account the renewal of the farm sector strike (see JP Morgan Research, by Florencia Vasquez—May 01, 2008: “2009 GDP forecast cut to 3% on mounting constraints”).

- In the mist of these inconsistencies, although within a small range, the domestic currency depreciated—despite central bank’s actions—i.e. there was small run against the peso, and is likely to continue, potentially accelerating. CD’s in pesos aren’t being rolled over and they are used buy dollars.

- Government expenditures are very high and are not decreasing. The amount of discretional redistribution from the poor to the rich has increased substantially, and it is expected to accelerate as the inflation rate keeps on increasing.

- Tax revenues increased; but this mainly explained by the inflation tax!

- Debt amortizations are very high and increasing for this year and the next ones—with very limited ability of the Argentine government to access international financial markets and at non-trivial high interest rate.

- Argentina’s national debt has not only increased in absolute volume (some estimates putting it close to US$ 200 billion) but it has increased as a percentage of GDP! Furthermore, this is a lower bound. If correctly computed, it is already in “Danger Zone” (see IDB’s report). No wonder that some other reports has estimated Argentina’s default probability to be the highest among emerging markets!!!

- Income distribution is deteriorating at an increasing rate (wasn’t this a “national and popular” administration?). For analysis I did early in 2007 see HERE (in Spanish).http://uoregon.edu/~magud/Redistribucion.pdf

- Price controls are still in effect. But they are totally ineffective.

- The latter, jointly with a (convenient) change in the measurement of the Consumer Price Index is the only inflation-reduction strategy of the administration!

- The number of bankruptcies is increasing.

- The housing market (one of the main engines in this “model’) is decelerating.

- Terms of trade bonanza is not such a thing, Jose Antonio Ocampo and Maria Angela Parra have shown. And the world economy is now slowing down.

- The Fed is already suggesting interest rate hikes could come sooner than expected to control U.S. inflation.

- The Euro area is slowing down.

- China and India are staring to be affected by higher inflation rates, which suggest that some decelerating of these overheating economies could be expected—and good for them. This, in turn, might impact on other parts of Asia.

- The commodities’ boom has slowed down in line with some small appreciation of the U.S. dollar. If the dollar continues to appreciate, this effect is likely to strengthen. The more so if the Fed increases interest rates and the economy, though slowly (as expected) progressively recovers some of its strength.

- Political acceptance of the five-month-old government is already very low (it looks more like a government about to finish its term in office, not an administration that has been in office for less than a year).

- The strategy of the current administration seems not to attack the source of the problems—the mismanagement of the macroeconomy—but to try to generate social tensions (e.g. t stimulate “class” divisions) to avoid the solution. Furthermore, I wouldn’t be surprised if the administration will eventually let things collapse and then blame “the market” for the problems (it is always “another one’s fault”).

Some Thoughts

The above were just a(n) (incomplete) list of facts. Interestingly, I would have written them in the early-mid seventies, most of them of have been true as well! (and a “funny” way to write a sad piece). So, we saw this picture, and how its ends. Would you put your money in Argentina? I won’t.

For a future posting: I am totally not surprised by the recovery of Argentina: the economy started from a huge collapse in 2001-2002 while its was favored by the so-called savings glut along with China and India (and the world economy as a whole) growing at high rates for a long time period—and the effects that these caused on commodities, the main source of exports in Argentina.

But now, in light of one of the worst macroeconomic admistration in Argentina’s history I am starting to think that the global context, instead of a blessing, it has been a curse. If so, the long-term costs of this will not be small.

Is the Party Over in Argentina? The Market Internalizes the Political Effects of Inconsistent Macro Policies (or vice-versa?)

This posting appeared in RGE-Monitor (Latin America) on April 23rd, 2008

The last couple of days financial markets in Argentina have shown capital flowing away from government bonds and into buying dollars (hoarding them, “jus in case”). This might seem at first glance controversial with the apparently sound macroeconomic figures: fiscal surplus, current account surplus, high growth rate, low official inflation rates, etc. I will argue that it shouldn’t.

Many commentators are suggesting that this is just a political problem—the government vs. farm producers conflict. In my opinion, if anything, the political frictions are just the trigger that shows how the market is internalizing the 5-year long macroeconomic mismanagement—with no long-term view. It clearly reflects the fact that, as I mentioned many times in my postings, even though the flow figures show an apparently solid economy the stock (i.e. intertemporal sustainability) show exactly the opposite.

The fiscal fragility is evident once one considers the heavy debt repayments due this and the coming years, the fragility on relying of very volatile (and temporary) sources of tax revenues to finance permanent expenditures. The former not only includes the export taxes, but also the inflation tax (this last one eventually decreasing as inflation gets out of controls—as it is currently happening—and the Olivera-Tanzi effect jointly with higher tax evasion and lower GDP growth).

Of course, decreasing government expenditures is political impossible for now, as it is appreciating the currency. On the latter, everyone would have expected the domestic currency to appreciate if let to float instead of depreciating[1]; unless this is the starting point of a standard textbook balance of payment crises… We can not rule out this happening (although with a low probability for now it is likely to increase over time). Why? The huge amount of debt needed to roll over in times of dry international financial markets (not to forget that Argentina has not even had a great amount of access to it in the so-called savings glut times) plus an election coming next year. Because let’s face it, the Kirchners receive political support due to the asymmetries in the tax revenue collection (mostly Federal) as opposed to the local (Provincial) expenditures that they manage to control the provincial and local governments.

By the way, the figures in the real side of the economy don’t look that promising either. GDP growth is decelerating as well as house sales, credit is still very limited, inflation is accelerating, provincial fiscal deficits are arising and increasing, lack of investment, energy shortages, wages indexations (although they are already running from behind to the inflation rate), ineffective price controls, increasing crossed subsidies to ineffectively trying to reduce price increases to middle-class, increasing income inequality (the more so the greater the inflation rate), lack of a nominal anchor, no long-term growth plans, lack of productivity-based wage increases, a reasonable exchange rate policy, serious anti-inflationary strategy, respect for the rule of law, etc. (the list can be extended as long as necessary, unfortunately).

It is true that there exist an international inflation problem. But Argentina’s inflation rate has dramatically separated from world inflation. Most of the other Latin American countries raised interest rates to try to reign in their inflation rates. Will Argentina be forced to do it in trying to stop a currency crisis? Hopefully the wrong macro-polices of the past will be recognized in a timely manner and the changes will be made. Even those that originally promoted the so-called “productive model” are now being cautious on reporting the need to correct the deviations. Aren’t they the smart ones that should have anticipated these effects?

The problem is that the longer it takes for corrective measures to be applied the greater the real effects and the more drastic adjustment would need to be. This resembles more and more over time the famous “war of attrition” of Alesina and Drazen (AER 1991): reforms are delayed until they are inevitable; but the costs of such lengthy wait are non-trivial. It also rings a bell in the credibility of inflation stabilization literature (Calvo and his co-authors have been teaching us this since the 1980s!)

Conclusion: I hear a tic-tac. Argentina is running out of time at an accelerating rate (as the inflation rate is clearly indicating). Things are still correctable. But the longer it takes, the greater the pain (i.e. real effects). Commentators presume it is just a political problem. If true, it is because the market is internalizing the huge macroeconomic mismanagement (that I have elaborated on in my previous posts). The market, being forward-looking, is signaling it. The political conflict is just the trigger of economic problems that the society in internalizing. Let’s hope that this time the government is able to interpret the signals and avoid repeating the same mistakes of the past.

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[1] And the central bank could be so creative as to claim responsibility for increasing exchange rate volatility on purpose to stop speculative capital flows.