Homo Economicus or Homo Argentum?

My "I will defend the exchange rate at any cost" t shirt is leading people to ask too many questions already answered by my shirt

sick helmet ngl

Argentina, unsurprisingly, is a mess right now. Surprisingly, the global media is on it: the Financial Times has described the current situation as “the worst crisis in his presidency”, while the markets are entering panic mode: the stock market is at 13 month lows, government bond prices are down 3% with yields all the way up at 16%, and country risk premium soared to 1,500 basis points, more than double the levels of a few weeks ago. What are we doing?

Kuka risk and the 3% rule

The inciting incident was two weeks ago: on September 7th, the Province of Buenos Aires (home to 40% of Argentina’s population) held provincial legislature elections. Most pollsters and analysts expected a Milei loss of around 5%, not much worse than his 51-49% defeat in the 2023 runoff. Instead, he lost by a staggering 14 points and the Peronist Party carried 6 out of 8 electoral jurisdictions, including three it hadn’t won in twenty years. Milei’s party’s vote share fell in every single of the eight “sections”, and he lost by 10 points in the crucial first section, which is both a bellwether and a major economic hub for the province’s “new economy”. Much more interestingly, his electoral coalition also changed: from being an alliance of the patrician upper classes, the swingy middle classes, and formerly Peronist lower middle class and working class voters, his new coalition is just the same old, same old “viejos meados” (urine-soaked old seniors, as the president called them) of the “old right”.

Why the big loss? There’s, basically, three big reasons. The first is simply political exhaustion: Milei’s administration is currently much bigger on culture war issues than on actual policies, making the first case of its midterm campaign about transgender children, an issue nobody cares about. Milei has already gotten burnt on this sort of thing this year, with massive protests against comments widely understood to be about him accusing gay parents of being pedophiles. He’s also picked extremely unpopular fights over disability benefits, funding for pediatric hospitals, and funding for public universities, and he’s lost all three fights, badly. The government has faced around 35 fights with Congress: between taking office and March, Milei’s party won all but one of the 15 votes. Since April, it’s lost all but one of them.

These political headaches are more a reflection of his loss of support than a cause of it, though. The composition of Congress hasn’t changed; rather, its willingness to cooperate on Milei’s priorities is. A second issue for Milei right now is corruption, not just the ongoing LIBRA scandal, but a second, much worse one: his sister Karina¹, called “the Boss” by him and appointed General Secretary of the Presidency (the highest ranking non-Cabinet office in the executive branch), is under fire for allegedly taking bribes from, among other groups, the disability benefits administration. A leaked voice note from Milei’s personal lawyer claims that “Karina takes 3%”, which has gotten so viral that panhandlers on the subway quip about it. There’s also scandals around plum contracts given to politically connected pharmaceutical companies, and (unproven) accusations of corruption against the President of the House of Deputies, Martín Menem, and his relatives in the administration. People are really angry about this, to the point where Milei got pelted with broccoli, eggplants, lettuce, and, less entertainingly, rocks during a campaign rally, at the same time as one of his major supporters and lead candidate for congress in the Province of Buenos Aires had to flee the angry crowds on a motorcycle.

But, historically, corruption allegations themselves haven’t hurt a government directly. Néstor Kirchner’s Economy Minister got caught with a duffel bag of cash in her office right before the 2007 presidential election and his wife still won comfortably. Corruption scandals dogged Carlos Menem’s late first term and, again, he still won. The main scandals that did hurt governments, like the second term Menem scandals, the leaked video of Cristina Kirchner advisors weighing cash in a restaurant, and the “VIP vaccinations” 2021 scandal, happened in a society that was already feeling some economic pain. While inflation has decreased substantially, the economy has not picked up speed: GDP shrank 0.1% q/q in the second quarter, and most indicators point to the cooldown continuing in July and August. Retail sales are in the toilet in response to consumer credit drastically slowing down from Q2 to Q3, as well as real wages falling for the first 6 months of the year, employment falling off a cliff since November 2024, and business closures on a rate similar to the COVID pandemic. Unemployment is higher and job creation is still precarious. Compared to 2023, the economy has grown around 3%, but unevenly: beyond the recovery in agriculture (affected by a drought for most of the year two years ago), and big growth in fishing, mining, and oil and gas, the economy has shrank around 5% when it comes to manufacturing, construction, retail, and non-tradeable services. The “winning” sectors are nowhere to be seen in the Province of Buenos Aires, as many on social media have pointed out, while manufacturing and construction make up a gigantic share of employment there - hence the drastic change in fortune of the government, with an 11 point swing from just 2 years ago².

The fact that the government is deeply trailing in the country’s biggest province after a series of undistinguished performances in ten other provincial elections this year (only winning in the dyed-in-the-wool antiperonist City of Buenos Aires by poaching 5% of the 2023 electorate from a center-right competitor) seems to have worried the markets: the exchange rate jumped 8% in the following two weeks and the financial markets are freaking out, as mentioned above. The Economy Minister, Luis “Toto” Caputo AKA the Messi of Finance went on a podcast to clarify two things: first, that he would “sell up until the last dollar” to defend the exchange rate, and second, that the financial freakout is only caused by expectations of a potential Peronist landslide in the national October midterms, what he calls “kuka risk”³.

Let’s start with the second statement. I have a lightly edited and translated quote from a prominent economist: “faced with higher country risk, the incompetents in the government are saying it’s caused by fear of Peronism. First, the risk premium is up because the country has unsustainable and explosive debt growth that will make it insolvent. Second, if Peronism grows it’s because of ruling party incompetence”. The statement comes from pre-politics Javier Milei speaking about the 2018 currency run, which Caputo was also involved in responding to (as head of the central bank).

Was he right?

When you wake up next to him, in the middle of the night

Let’s start with the first half, the unsustainability of foreign debt. I’ll take a detour to the United States first: Kamala Harris launched a Substack this week, featuring the following excerpt:

Gore Vidal called them “the four most beautiful words in our common language”:

“I told you so.”

I disagree, I don’t think they’re beautiful, and I wish I had no cause to say them.

Harris is almost certainly oiling up a third presidential campaign, so she has to be gracious to Apemericans. Fortunately I don’t have to show grace to the Argentinian voter (who, regardless, doesn’t read C list English language blog posts), or to international observers who bought the hype, like Niall Ferguson. So, I told you so.

The last time I wrote about Argentina was a month ago and I didn’t expect to write again until after the elections next month. But my position is that the government was digging itself into a hole it couldn’t escape. The problem is as follows: the government came up with a new monetary policy scheme where the central bank controls only the quantity of money and interest rates are set by the markets. The government also doesn’t control the exchange rate, which floats freely between two bands - and if it crosses the upper band, the central bank will sell as much currency as required to stabilize it. The plan was that the economy would de-dollarize endogenously and would push down both interest rates and the exchange rate, leading to a virtuous cycle where the economy boomed, disinflated rapidly, and the central bank picked up reserves. The problem is that the transition into this new scheme was very rapid, so it pushed out a ton of liquidity that started flooding into the currency market in June and July. The government’s solution was to raise interest rates, which put the main stabilization tool the authorities have (a stable fiscal surplus) at risk because of ballooning interest payments in short-term capitalized bonds. And capitalized bonds are already an enormous issue, with their Jan-Jun interest payments being six times larger than the fiscal surplus the country had in the first half of the year.

The fundamental issue isn’t really fiscal or monetary, but rather, a big currency imbalance: there’s very limited capital controls as a way to attract foreign investment and because of ideological reasons. The problem is that free capital flows also created a staggering deficit in the services trade, with massive demand of hard currency for tourism, imported crap from Shein and Temu, and various types of services and profit repatriations. The core plan, thus, is to finance the current account deficit with a financial account surplus, i.e. to let foreign capital into the country. Per the interest parity equation, this means that real returns for foreign capital are equal to the risk premium plus the interest rate times the expected change in the real exchange rate.

This means that there’s basically two options to solve this and they’re both bad. The first option is to have much higher interest rates, which was the plan from June until right after the election. Tight money attracts foreign capital and means lower inflation and a cheaper exchange rate. The problem is that permanently tigher monetary policy crushes the nontradeable sectors that employ most of the country’s population, which would put Milei’s reelection at risk, not just because of the direct impact, but also because it would make the country’s fiscal picture completely unsustainable and require deeper and deeper budget cuts to keep paying a ballooning interest rate bill.

The second option is to have a much higher real exchange rate, which would reduce currency outflows and increase financial inflows without needing higher interest rates. A first problem with this strategy is that there’s no such thing as an “immaculate” depreciation, which needs a readjustment of relative prices to work - meaning either a recession, or inflation. On the long run, it would mean either reduced consumption or reduced investment, because smaller trade and services outflows require less spending without a productivity increase. The debate between economists around the topic is very intense, but my take is that if the credibility of the government program is maintained, an FX spike wouldn’t be translated into prices, which would mean that businesses would have to eat the costs and, in many cases, slim down or go under. If the credibility isn’t maintained, then it would pass through to prices, which risks just becoming another inflationary spiral. The first case is, right now, likelier, because the 10% spike in July mostly hasn’t, with a 0.5 p.p. increase in core inflation between July and August, and a 1.5 p.p. hike in producer prices. But both of these options would be politically deadly for Milei. The second problem is also fiscal: the country has gigantic foreign obligations for basically every year this decade, with 18 billion dollars for next year and just 20 billion dollars in liquidity to pay for them. If the exchange rate is fixed at a high level, the central bank would accumulate reserves from the current and financial account surpluses, but per Mundell’s Trilemma, without capital controls and with a fixed FX then all external shocks would be absorbed as higher interest rates, which is again very undesirable. But if the government floats the exchange rate, even discounting that the surplus wouldn’t last because high FX adjusted rates would attract capital that would push the currency down, then it wouldn’t accumulate reserves (definitionally), and therefore wouldn’t be able to pay for its 18 billion in obligations without a truly behemoth fiscal surplus.

This all means that, no matter where you cut it, the current policy mix is completely unsustainable: the country has a gigantic foreign debt it’s nowhere near able to pay, interest rates that can’t go too high or too low, an exchange rate that can’t go too high or too low, and it’s all held up by a fiscal surplus that would be blown to pieces by any combination of exchange rate and interest rates under current policy. This means that, if you’re a foreign bank, you’re guaranteed to not get your money back without a big policy shift, which is why country risk is 1,400 points and why real bond yields are at least 16%.

Milei and Wilei

The obvious question here is whether the marker uncertainty comes from the government maintaining its current failing policies, or from the failure of those policies leading to an even worse government - kuka risk. Well, who’s even on the other side of the polls here?

The main leader of the Peronist Party was, until really recently, former President, then Senator, then Vice President Cristina Fernández de Kirchner, or CFK. Except she’s both extraordinarily divisive as a political figure, and much more importantly, was banned from running for office for 6 years by the Supreme Court. This left the party acephalous until the Buenos Aires election, because the whole thing was a gambit from one person only: the province’s governor, Axel Kicillof. Kicillof will be termed out in 2027, after eight years in charge of the country’s largest electorate, and before that he was a congressman for 4 years, and previously Economy Minister under CFK herself. He’s kind of Milei’s Wario: Milei is a neoclassical slash Austrian economist who has written books praising Friedman and Rothbard; Kicillof is a Keynesian slash Marxist economist who has written books about Marx and Keynes. Milei is hyper conservative yet childless and unmarried, with only short term flings; Kicillof is a “gender inclusive language” progressive, but has two sons with his partner of over 20 years. Milei has five cloned pedigreed dogs, and Kicillof has two cats he picked up at a campaign stop. Milei is a deeply religious convert to messianic Judaism; Kicillof is secular, but was raised Jewish by his parents. And, just like Mario and Wario have both mustaches, Kicillof and Milei both have sideburns.

Is Kicillof a risky bet for the markets if he were to take the presidency in 2027? Yes. In a recent interview, he clearly hadn’t changed much of his economic thinking from his last time in national office ten years ago. He remains noncommittal on the importance of fiscal prudence, remains noncommittal on the importance of central bank independence, and doesn’t have a strong argument for why his biggest blunder, the still contentious nationalization of state-owned oil giant YPF, wasn’t a mistake. A recent article has described the current struggle as between Milei’s political flat-eartherism and Kicillof’s economic flat-eartherism. The big risk with President Kicillof is that he would expand the deficit with monetary financing and auction off reserves to sustain a too low exchange rate, causing another inflationary spiral and even more real output stagnation. Kuka risk is somewhat plausible as an explanation.

But it’s not the entire explanation. There’s a second source of risk: time inconsistency. Milei’s theory of change right now is that, if he wins the midterms, foreign capital will come because of his greater ability to pass permanent reforms. To win, he has to keep the exchange rate and interest rates at bay, which means burning copious amounts of reserves: he sold 50 million on Wednesday, 350 million on Thursday, and 700 million on Friday, for a total of 1.1 billion in three days. As I mentioned, the Central Bank has 20 billion on hand, give or take, with a few billion in interest payments until January, when it has to shell out 4.5 billion to bondholders. So it really has 15 billion. At the rate of last week, it would need 9.2 billion to hold off until the elections, and would run out by mid-December, on Milei’s two-year anniversary in office. At the rate of Friday, it would run out two days before the October 26th midterm elections. So the government needs to figure out a solution to its currency conundrum before the end of the year, and it’s very clear that either of the two possible solutions given the current policy suite would be unsustainable in the medium term.

This creates a trade-off between short term and long term sustainability of the currency scheme. At the top of the bands system, the the central bank operates a de facto peg), and under a pegged exchange rate, there is a point at which critical mass is reached and the markets buy out the entire stock of reserves to get a windfall profit. The amount of money it would take is the exchange rate times the reserve stock. One way you can figure this out is by observing shadow prices, which are the actual market exchange rate (i.e. the money stock divided by the reserve stock), and they loosely correspond to parallel market exchange rates. Until this week, the “black market” rates were around the same as the official rate; since Wednesday, all major alternative rates have traded above the band ceiling, meaning that the markets don’t believe the current policy scheme anymore. But, as anyone who knows anything about economics could guess, the inevitability of abandoning the current FX scheme from market pressure can make it become a self-fulfilling prophecy, since if you buy dollars today they’ll always be cheaper than tomorrow. Which means the pressures won’t die down on their own because the more time passes, the sooner the depreciation, incentivizing purchases. One way to delay this is by tightening monetary policy, but this also means tanking the economy right before the election, signifying instant defeat. And it’s plausible that the government exhausts its reserves and still loses, because nobody expected them to lose by 14 points two weeks ago anyways.

Conclusion

So, as I’ve said basically every time I’ve written about the topic, the problem is pretty simple: the government’s adherence to open economy orthodoxy means that it needs to both let go of interest rates and exchange rates, which under episodes of uncertainty, can produce explosive dynamics - particularly because of concerns over fiscal sustainability. Both sides here are right: the Peronists criticizing Milei’s program as unsustainable are correct, and Milei warning of the boogeyman of Peronism is also correct. The problem is this puts the government in a hard position: If Milei changes plans too quickly, he’ll lose the election and the country will become ungovernable, rapidly increasing inflation. If Milei changes tracks too late, he’ll exhaust his options for international funding and will have to inflate away the debt. If Milei’s follow-up plan fails, his opponent will inflate away the debt.

The only solution is for the government to grit its teeth until October and then figure out a more sustainable approach ASAP. But given how long they dragged their feet on exiting the fixed peg last year, I’d assume they’re going to drag it out until mid 2026 at the latest, which is why Milei is trying to get Trump and Bessent to give him 30 billion dollars as we speak.

But is it reasonable to expect that Milei would put his own political survival ahead of economic rationality? Well, yes. Back in 2019, there was a ferocious debate between economists Federico Sturzenegger and Rafael Di Tella over what had gone wrong; Sturzenegger blamed fiscal policy, saying they pressured him to lower rates too fast, causing an exchange rate crisis. Di Tella instead attributed the fault to excessive optimism and, particularly, to prioritizing short-term political gains over disinflation. So it’s not unprecedented behavior to err like this. In the present, Milei has been boosting a movie called Homo Argentum, to the point he made his entire cabinet watch it at least once. The movie’s core theme is that Argentina’s economic issues are caused by a bad culture that encourages dishonesty, self-advantageous behavior, and short-sightedness. Milei’s political career so far has been dominated by extreme ambition and risky, high-stakes gambles: he ran on a radical platform of deregulation and austerity, won, implemented a less extreme version, and beat expectations. His current problem is not too much ambition, but too little: focusing on winning the next election at all costs, without realizing that without a sustainable plan, he’ll lose everything sooner or later. This has been the fatal conceit of every stabilization program in Argentina: trying to win every battle at the cost of losing the war.

So the question remaining about Milei is who is going to win out: the Homo Economicus, demanding a sustainable solution to the external imbalance, or the Homo Argentum, who will put political sustainability above the economic one?

1. People who read my notes on this site might know her as the one who is suing an obscure transgender streamer for defamation over the streamer saying Karina, allegedly, “looks like a transvestite” and “goes around scaring children like the nun from The Conjuring”. The video went viral, leading to a social media trend where people recorded themselves repeating those lines in various languages. And the streamer is getting pro bono legal advice from a Catholic integralist primitivist politician who ran for President in 2023.

2. If you want to get really technical, in the 2023 gubernatorial election Peronist governor Axel Kicillof was reelected with 45% of the vote, while the centrist PRO party’s candidate got 27%, and Milei’s candidate finished third with 25% - meaning that Kicillof trailed the PRO+Milei alliance by 7 points. On September, Peronism only improved its vote share by 2 points, but Milei and his allies lost 18, so the net swing was ~20 points against LLA.

3. The term “kuka” is a derogatory term for Peronist party supporters under the Kirchner family, both as a deformation of “K” (pronounced ka in Spanish) and as a shortening of the Spanish word for cockroach, cucaracha. Not a very ministerial way of speaking but what can we expect from someone who’s already called the “kukas” (mentally) disabled.