Good On Paper?
♫ Sometimes I feel like I just wanna go back to my old ways ♫
Argentina’s President Javier Milei has wrapped up his first year on the job a month ago. The traditional first year anniversary present is paper, hence the title, and a more modern one is clocks. So let’s spill some ink on how Milei has been doing as the country’s top dog: contrary to what everyone (including, full disclosure, me) expected, it’s been good enough. Can he keep it up for 2025, in a year that will no doubt be dominated by the 2025 midterms and Trumpian madness?
The numbers, what do they mean
So how is Milei faring, numbers wise? Well enough. The economy entered a really big recession more or less immediately after big economic adjustments, and slowly recovered starting in May. Given that the economy started shrinking late in 2022 and fell 1.6% in 2023, plus a drop of 2% to 2.5% in 2024 (Q4-24 data still not out), plus some extra bounce in exports, GDP growth should be north of 4% this year, even without some kind of economic miracle.
The big one people are looking at is inflation: 117.8% in 2024 - lower than the 211.4% in 2023, especially comparing just December (25.5% last year, 2.7% last month). Overall, prices seem to be under some degree of control - core inflation ran a tad high (because of higher beef prices), regulated prices continue increasing 3.5% a month, but overall the big story is stable services price growth at 4.5% monthly, and goods price growth at 2% a month. This basically points to two dynamics: on top of regulated services, “core” services (i.e. wages) are growing around 2% a month in real terms, and goods prices are staying close to the 2% monthly exchange rate devaluation. So inflation could have a lot of stickiness going forward, right?
Kinda. The government recently announced that the monthly depreciation rate for the official exchange rate will be reduced from 2% to 1%, basically so prices can fall even further. At the same time, the Labor Ministry is signaling that they won’t support any wage agreements over 1% a month (nominal), which isn’t really a lot. This is all a ploy to get prices to crack 1% and thus finally be able to remove restrictions on capital markets as the government promised (to be fair, when this is going to happen has been a major question for a really long time, or what is going to come after that).
This obviously would be bad for the external sector: inflation isn’t really expected to crack 2%, let alone 1%, until halfway through the year. After devaluing the peso by 118% last December, Milei has kept it growing at 2% a month (so approximately 27% in all of 2024), which is so behind inflation that the real exchange rate is now lower than when Milei took office. In layman’s terms, this means that buying Argentinian goods and services internationally is more expensive, and buying foreign is cheaper. The impact would be mostly felt on reserves, which to be fair have been growing quite a lot (by around USD 4 Bn since September, very significant compared to “normal” fourth quarters), but net reserves (i.e. the ones the government can use) haven’t really expanded much: they were at neutral levels in June (versus -11 billion in Dec-23), then declined to around -5 billion in October due to a bunch of debt payments and bad months in the currency market, then bounced to around -3.5 billion by end-year. 2025 will not be a good year, since the country has around 3 billion in IMF payments and 9 billion in private debt payments, as well as keeping taxes on exports and reducing taxes on imports.
The fiscal situation, relatedly, is good: December had a moderate primary deficit (due to mandatory end-of-year bonuses for employees), but the year finished in the black for the first time in fifteen years. For the upcoming year, we shouldn’t really expect the government to raise spending (well, unless they’ve gone Woke), and the tax revenue lost from recent cuts in import taxes should be made up by higher revenue from taxes on wages and linked to spending and output (VAT, income, wealth) as the economy grows. The president is now talking about “eliminating 90% of taxes”, which sounds impressive until you consider that, out of 155 federal taxes, 5 make up for around 90% of revenue (VAT, income tax, social security taxes, export tax, and the baffling bank transfers tax), while the glup shitto taxes Milei wants to cut are basically all excises on stuff like radio broadcasts fuel and cigarettes. Put together they make up around 0.5% of GDP (after excluding import taxes), which isn’t a big burden for the government. Plus, a lot of them finance specific funds or projects (most notably, the cigarrette tax funds uh tobacco plantation subsidies), so it’s not really clear how a very legislatively weak government can eliminate those funds, or why they would remove the revenue but keep the spending.
I’ll make a final, monetary-flavored note here: money demand seems to be recovering nicely, after plummeting in real terms early this year. Credit and aggregates such as private sector M2 (which is the cash + bank deposits from the private sector) have grown very fast lately and are rapidly returning to 2022 levels, which to some extent signals greater macroeconomic confidence amid disinflation. The recovery in credit is both driving and being driven by the economic recovery, and it should not be inflationary as long as monetary demand recovers alongside it.
The contours of a plan
I previously mentioned that the government doesn’t seem to really have a clear plan for the economy, but it’s transpiring that they have the general shape thereof.
The direction the government is taking is what’s called currency competition, not in the Hayek “private bank money” sense (we’ll get back to Hayek though), but in a much more mundane way: that people get to make contracts either in the local currency, or in other, foreign currencies - namely the dollar. Argentina has a very high demand for dollars, largely responding to economic uncertainty and high inflation (the US dollar has a very bounded negative return but also low real positive returns, basically, and serves as a hedge against tail risks). For historical reasons mainly, most of these USD savings are outside the financial system - the “mattress dollars”, in local terms. Without forcing people to do that (which doesn’t work), how do you get these dollars back into the legal economy?
The Milei currency competition idea tries to reconcile this by giving both currencies legal tender status: that means contracts and transactions (including wages and prices) can be conducted in either currency. For instance, a recent Central Bank regulation decrees that the QR payment system be interoperable across apps, and that all of them allow from payments in whatever currency the payer has in their porftolio (I assume, from the wording, that this extends to crypto “currencies” too). This was part of the 1990s Convertibility Plan (which I’ll get back to in a bit), which also fixed the exchange rate by law.
Importantly, the Milei Currency Competition framework does not specify monetary policy, at least not ex-ante. This opens, broadly, two pathways: the first, implemented across Central America, has a “passive” central bank that is not empowered to set an exchange rate or issue new money without corresponding increases in the supply of “hard” money (dollars), which resulted in the dollar basically overtaking the local currencies. The second, which is the Peruvian path, has an active central bank and an actively managed exchange rate - giving the domestic currency, the sol, the leading part1. But overall, the idea is to have two currencies circulating in an orderly and well regulated fashion - so why is there only one in actual use?
The thing here is what’s called Gresham’s Law: basically, that if there is competition between two currencies of different values, the “bad” one will drive out the “good” one from circulation because people will hold onto it for savings and not for spending. At fixed rates of exchange, this is driven by quantity: if there’s more silver than gold, then the price of silver has to be lower, and gold will not be spent, being more valuable. Eagle-eyed viewers might notice that, in Central American Currency Competition, the dollar is the “bad” currency because there’s more of it (it isn’t feasible to dollarize at a low real exchange rate, for very obvious reasons) - the domestic currency just disappears because it’s irrelevant.
In Hayek’s vision, the “good” currency drives out the bad at floating rates, because they have to reflect the fundamental trustworthiness of the issuer, and a less trustworthy currency is also riskier to use and would have lower purchasing power (due to higher supply and lower demand). One of Latin America’s major macroeconomists, Julio Olivera, points out an “error” in Hayek’s reasoning: to reach a corner solution where only one currency is used, then preferences can’t be “rational” in the sense that economists use the word, and it doesn’t make a lot of intuitive sense for money to not be a normal good. Now this is getting tedious and I’m not going to delve into a math dispute between two major figures in 1950s economics, but it should be kept in mind that it’s not necessary that only one currency be in circulation.
This gets to the actual origin of money: the “metallist” version of the origin of money has to do with the value of gold as a means of exchange and of storing wealth, and the “chartalist” version is that money’s value is backed by the power of the state. Not to get too wordy, but my view is that the chartalists are unambiguously correct, but it also helps explain why the domestic currency could dominate even when the government doesn’t tilt the field for one currency like in the Peruvian case: the government has monopsony power over currency because basically everyone has to pay taxes to it. If the government only accepts one currency (be it its own or any other), then that currency immediately has a much larger share of transactions than all the others just because so many transactions either are or involve taxes.
So, which way is Milei leaning for his currency program? In rhetoric, he’s always seemed like he’s going to turn the country into Ecuador: he’s mentioned wanting the peso to be “the strong currency” and it does seem more on brand to string up the central bank so hard that it can only increase the supply of pesos if the supply of dollars increases first. However, that’s not the tune that his central bank is singing: via very convoluted charts, the BCRA is basically saying outright that they’re going for the “Peruvian” model, where the bank can conduct autonomous policy operations - it just changed the conduit so that it could not create an explosive growth path for its liabilities again (which, in the government’s view, was imminently hyperinflationary). The supply of dollars into the financial system has increased lately (as part of Milei’s capital regularization program), but the increase in real credit both preceded and exceeded it in scope, which makes me think that they’re not going to drown out the economic recovery just because the dollars stopped flowing - in fact, the regularization program working at all, and especially people not pouring their dollars out after the mandatory holding period, points to greater trust in the domestic financial system (and thusly in the peso) being a driver and not an outcome.
Milei versus Dark Gothic MAGA
So we have at least the “contours” of a plan in terms of monetary management: a fixed exchange rate plus a mostly autonomous central bank that somewhat actively manages the supply of money, in a country with a fiscal surplus and a well regulated “bimonetary” economy. Is it going to work?
The obvious point of comparison is the 1990s Convertibility Regime, which was a currency board that featured three main planks: a fixed, “one-to-one” exchange rate set by law, a heavily constrainted central bank, and a limited “currency competition” framework where prices and wages could be expressed in either currency. The main issue was that a combination of initially slow disinflation coupled with and international currency depreciation in major trading partners (particularly Brazil) led to the peso becoming increasingly overvalued2, which damaged the balance of payments and put the financial system at risk as deposits left banks considered at risk of collapsing (especially with a heavily constrained lender of last resort). In addition, the government’s fiscal situation was weak, with a deteriorated primary balance due to a badly designed pension reform, as well as high interest payments from past debt; this, as well as the overvalued currency and the high risk premium, pushed interest rates up and public spending down, leading the economy into an extremely prolonged recession due to the necessity of an “internal devaluation” to balance out the external appreciation, a strategy that has generally been carried out mostly ineffectively and mainly through a large reduction of demand.3
The peso is overvalued at the moment, according to the creator of Convertibility: high initial inflation and a low nominal depreciation rate has led to the real exchange rate being lower than before Milei took office, though with a substantially healthier macroeconomy. The recent surge in the Brazilian real, which was devalued by 25% (as much as the peso!) over 2024 and cracked 6 per dollar for the first time basically ever, is especially concerning given that, over the long term, both currencies have tended to even out on the average in real terms - meaning that the peso is probably overvalued by around 20%. So Milei’s program of stabilizing the economy on an exchange rate and fiscal anchor faces already one massive risk.
However, the situation isn’t quite Convertibility tier. Firstly, so far there haven’t been many changes to prudential regulations, which strongly limited exposure to the currency market and thus avoid the systemic financial issues. Secondly, the Convertibility program also put the exchange rate as part of the law, which Milei hasn’t done - the currency market rule is set by the Central Bank, and they could change it if need be. Lastly, the pressure on interest rates isn’t as large: the current rate is 32% (around 3% monthly equivalent), which is significantly higher than the proposed new crawl - which could crowd in speculative capital and expose the country to a balance of payments crisis4. One of the major triggers for both a really prolonged deflationary episode and a complete economic implosion after Convertibility ended was that every contract in the economy, as well as the entire financial system, was exposed to the aftershock of rewriting the currency board rules, which is not the case if the country is moving closer to the Peruvian system.
A major sticking point for the currency overvaluation’s sustainability, however, is the now-inaugurated Trump administration: Trump’s program of tariffs specifically. The domestic effects to the US are more or less irrelevant, but this Peterson Institute estimate points to global impacts that are very adverse: higher interest rates, a stronger dollar (and therefore lower commodity prices), and weaker (emerging) currencies. Despite Milei himself being at the inauguration, and being “oomfs” with Elon Musk, the Trump macro agenda would be extremely damaging to the sustainability of an overvalued peso, putting pressure on a depreciation. In fact, Trump’s hijinks during his first administration and the Fed response to them were partly responsible for the sudden stop that tanked Mauricio Macri’s inflation targeting based stabilization program (note that this also featrued a high real interest rate for USD instruments and short-term financial flows, which Milei doesn’t have yet).
Milei’s advisors, however, discount the importance of the currency issue because they believe that the Convertibility’s issues were fiscal: because the primary budget surplus was insufficiently large to cover debt obligations, then the currency was under significant pressure in the case of a large debt sell-off (a combined currency and bank run, crypto-style). I am not going to get into specifics here, but as long as debt is perceived to be sustainably payable, then there would not be any financial shocks that unravel the currency program.
I’ve seen this one, it’s a classic
But the fiscal program is solid as a rock, right? Well, no. Despite the country clocking in an impressive positive balance of 0.5% of GDP, all signs point to consolidated government debt growing in real terms (it’s a matter of debate, though). There’s, fundamentally, three reasons: two havign to do with the prices of government debt, and one with its quantity. Regarding prices, the first issue is that, with a lower real exchange rate, the value of peso-denominated bonds increases in dollars. The second is quite complicated and technical, and has to do with the fact that a booming stock market and high demand for bonds reduces bond yields, which impacts how the bonds are valued in the budget. The quantity driver is the “LeFi” program: back in September, the government phased out central bank open market operations in favor of LeFis, a new bond that has a rate of return set by the central bank, but interests paid “under the line” (so outside the normal budget) by the Treasury. This means that the national debt increased, since their accrued interest payments are not captured in normal fiscal accounts but are captured in debt. Basically, the genuine increase in the quantity of debt, prices nonwithstanding, seems to be a result of the government shifting its liabilities from money-holders paying the inflation tax to its own balance sheet.
The issue here is a familiar one to longer-time readers: the Unpleasant Monetarist Arithmetic (DiCaprio pointing meme). If there is a fiscal deficit and an upper bound to the demand for government debt, tight money (or, in an Ivan Werning reedition, higher interest rates) cannot control inflation indefinitely - as soon as demand for government securities dries up, inflation spikes, since there is a deficit that is now only financed by the Central Bank’s money printer. The applicability to normal budgetary procedure is very complicated, and depends strongly on implied future deficits, but the LeFi system creates a pretty direct gateway between fiscal and monetary issues: if LeFi demand dries up because of any concerns with fiscal or monetary policy, then the government will have to redeem a large number of them, creating a significant “below the line” drain that imperils both the monetary and fiscal programs.
Fundamentally, you need to have a large enough budget surplus to pay off the interest rates for both regular and “below the line” debt at any real exchange rate, but at more and more overvalued currency rates, this becomes harder and less credible, especially because a currency jump would raise the cost of servicing USD denominated debt, forcing both a large sell-off of government securities and a currency jump, both of which imperil the monetary framework enough to perhaps un-anchor inflation expectations. So FX mismanagement out of a fear of floating could, in the end, destroy yet another Argentinian macroeconomic stabilization program.
Conclusion
One year in, Milei has done a pretty good job, mostly by abandoning nearly all of his moronic campaign ideas and replacing them with more reasonable, normal, and mainstream ones. From someone who derided Macri and his centrist approach as “a Peronist with good manners”, Milei has transformed himself into a Macriist with bad manners - and reaped appropriate results by behaving like a normal person, albeit one who is significantly more aggresive about fiscal consolidation. Given the dynamics presented, and the need to right the course of the economy on inflation-driven “bimonetarism” that follows a high deficit, badly managed economy.
And I’ll leave you with the song the tagline is from:
Sidenote here but Peruvian Currency Competition was designed to allow the dollar to be used but secondary to the sol, and the sequence of events was that dollars flowed back into the financial system, then the endogenous “legitimate” demand for soles increased and allowed for higher supply. The government, specifically, mandates that the sol be the “main” currency through prudential and monetary regulations.
For confused Americans, “depreciated” means an increase in the peso/dollar exchange rate (i.e. the peso becoming weaker), and “appreciated” means a decrease (i.e. the peso becoming stronger). Apreciation = bad because the country becomes less competitive.
They don’t phrase it like this, but the local commentariat does occasionally discuss a “virtuous internal devaluation”, which focuses not on thinning domestic demand to the bone, but on increasing domestic productivity and output to reduce cost.
Balance of Payments crises have been such a recurring blog post topic that they could very well have their own section, from Russia to Bolivia to Liz Truss of all people. The Bolivian one is pretty thorough.