One Month In

The good, the bad, and the crazy

i always try to go for weird pictures but there aren’t many these days

So the crazy guy has been president for roughly a month, and I wanted to offer an update about what he’s been up to. There’s been, generally speaking, three things the new President did: a big shock therapy program, a massive deregulation decree, and an “omnibus bill” to tackle multiple fields. He’s also focused on three spheres of action: short term, urgent matters; medium term stabilization, and long term structural changes. So let’s take a look one by one

The boring of hard planks

Before getting into substance, let’s get into the form: Milei’s reforms have (so far) largely been implemented by presidential decree as well as a plain reform bill, and he’s been constantly threatening he will take it straight to the people through a plesbicite if they fail to clear Congress¹.

The general way presidential decrees function is that the president issues over certain areas (can’t be tax law, electoral law, or other things that don’t really come into play here) and they have to be rejected by both houses of Congress to not be enacted by law. As previously mentioned, Milei’s legislative caucus is tiny, with just 37 out of 257 deputies, and 7 out of 72 senators. So it’s already looking shaky even when the actual regulations. It’s also precisely the kind of clash-of-powers, Linzian scenario that I originally said may bring out Milei’s more anti-pluralistic, "strongman” tendencies.

I’m also bringing politics into this because 1) him having a very slim margin of support in Congress is kind of relevant to whether his actual legislative initiatives can get passed into law and 2) shockingly, he has some political reforms.

First, the weird (and bad) one: he’s proposed a sort of vaguely defined emergency declaration that would grant the president vast emergency legislative powers. This is, of course, really unnecessary, particularly because of the economic credibility implications of the issue (more on this later). It was also bad when the previous president used such a vaguely defined emergency declaration to unilaterally decide on Argentina’s COVID policy, which was generally pretty disastrous. And it puts him on a collision course with the idea that institutional improvements are necessary.

Secondly, there’s an electoral reform involved. This has two big changes: one to ballots, and one to Congress. The change to ballots entails replacing the party-provided ballots that the government pays for with single ballots for all parties. This is a good idea and a very reasonable proposal that has majority support but wasn’t getting implemented for generally stupid and petty reasons. The other proposal is shifting from proportional representation to single-member districts. The precise reasoning isn’t really clear besides it somehow going against “the political class”, but it’s insanely stupid and has a really complicated history in Argentina: the first time it was enacted was part of a weird political debate on why exactly people weren’t voting, and the second one was a naked attempt to reduce opposition to the Peronist party in the national Congress.

All in all, the political stuff is generally not very good and kind of worrying, but not necessarily authoritarian, and part of a profoundly stupid conception of how politics should operate. There’s also generally a running thread of putting all public confidence on the presidency, which not great, stabilization-wise.

Shock and awe

Two days after taking office (on December 12th), Milei’s Economy Minister Luis “Toto” Caputo, the Messi of finances², announced his initial set of measures, tackling urgent issues in the economic short-term.

The most pressing matters consisted of a 3% of GDP primary fiscal deficit, extremely high inflation (over 10% a month) with deeply distorted relative prices (due to government controls), an incredibly overvalued exchange rate, large debts from importers to their external creditors, and a gigantic Central Bank balance sheet with a life of its own.

The most immediate fix one was a devaluation of the exchange rate from $366 per USD to $800, aka a discrete jump of 118.3% of the exchange rate. This has obvious, direct implications on prices, and obvious, direct implications on expectations. The genral idea was taking the real (inflation-adjusted) exchange rate from a level 40% below the long-term average value to one around 50% higher, mainly to give the authorities some breating room to maneuver for the summer. For the foreseeable future, the exchange rate will grow at 2% a month, which is strikingly below the 30% rate of inflation predicted for December, or the 20% expected for January, or the 15% for February. In fact, by March the exchange rate would have lost so much ground versus prices it’d be lower, in real terms, than in December.

The real FX is kind of important because the country has agreed with the IMF to add USD 10 billion to net reserves throughout 2024: this means that the government would take the reserve stockpile from roughly -9 billion (in December) to around 1 billion positive. Contributing to this is the reversal of a massive drought that would shore up both tax revenue (Argentina taxes exports) and the trade balance, but that would be sharply curtailed by the disincentives a big FX appreciation would cause.

Secondly, a series of announcement on fiscal policy that combine deep spending cuts with large tax hikes in order to reach 0% financial deficity in 2024 - that is, a 2.2% primary surplus, coupled with interest payments of around 2.2%. The composition of Milei’s fiscal program includes higher taxes on imports and USD purchases, higher export taxes, a reversal of previously supported income tax cuts, and a combination of changes to Argetnina’s wealth tax, a labor registration moratorium, and a capital inflow promotion strategy. This would add up to around 2.2% of GDP, or 43% of the adjustment - including large burdens on importers (who would pay an 17.5% surcharge on all purchases) and exporters, which on net wouldn’t affect the competitiveness of the economy. Spending wise, the government will cut pensions (by not increasing them at the same pace of inflation), cut subsidies, cut transfers to provinces, cut all public investment, and cut welfare programs and government stafffing - though, confusingly, there’s also been an emergency increase on welfare programs. The spending cuts, which are mostly reasonable, would add up to 3.0% of GDP, which is 57% of the fiscal effort of 5.2% of GDP.

The monetary leg of the program is the most confusing one. Faced with extremely high inflation and a need to shore up reserves and get rid of currency controls, you’d expect the government to raise interest rates, but instead, it has lowered them: the policy rate went from 133% in November to 100% now, as well as eliminating 28-day bonds to focus on overnight ones. The logic here is to wind down the Central Bank’s remunerated liabilities: in order to cover the money the bank printed to pay for the fiscal deficit, they issued 28-day bonds, which raised the future money supply (and thus raised inflation expectations). The banks will instead loan the money to the Treasury at negative rates, but because there's no deficit, the government will simply turn it back to the Central Bank. As long as the semand for money doesn't fall (i. e. a loss of credibility), then this should drive demand, and prices, down. This is also coupled with the fact that December and January have really high cash demand (because of seasonal factors: Christmas shopping, New Year’s partying, and the summer holidays), plus the imminent, deepening recession. If the government loses the trust of banks and investors, then the cash would find its ways to shops or the FX market (which is still tightly controlled), and would cause higher inflation and require high rates.

This is all fairly reasonable, and while it is obviously necessary to cut taxes at some point in the future, the problem with past stabilization programs was that the fiscal aspect was never implemented, and the monetary aspect was, meaning that the economy was eventually destabilized. While this is being averted, FX appreciation is not (so far), which means that there already is one sticking point on the Plan Milei. The cuts to transfers to the provinces are a welcome start, because the most successful stabilization plan in Argentina’s history (Convertibility) floundered there. Regarding the fiscal correction, I think that it makes one major mistake: while austerity measures do make recessions worse (I mean duh), those that preserve public investment tend to perform better in the longer run.

Stabilization and beyond

The Milei/Caputo Plan (we need a fun name for it, like Macri’s “Flinstones³ Plan” - the Chainsaw Plan, let’s say) is not a stabilization program, but rather, an emergency adjustment plan.

What’s the difference? Well, a stabilization plan tends to have four main planks: adjustment of major macroeconomic imbalances (monetary, fiscal, external), some manner of coordination mechanism for price expectations, some mechanism to preserve government credibility, and some form of mechanism to generate buy-in from society, especially labor unions.

Does Milei’s plan have this? Well, the first one is obviously there: the government has sorted out the monetary issues, is committed to fiscal reform, and has an unconventional but reasonable monetary policy. I am going to say that the government does have credibility: its fiscal targets (of a 2.2% primary surplus) are above what the IMF would have recommended, and it is probably committed to preserving Central Bank independence by the letter of the law. However, this is the part of the Milei Agenda that runs headfirst into the problems with the emergency power and the “megadecree”: if the new government aims to credibly change Argentina’s economic landscape, it can’t do it in such a way that the next President could instantly undo all the changes in a stroke of the pen. A government in such a small minority might even be advantaged by taking the legislative route, since it would stem from deep negotiations and agreements from a majority of parties.

The fourth one, the “social stability” plank, is shaky, since normally price and wage controls serve this purpose: the government has increased some welfare payments substantially, but its austerity and (especially) reform measures are controversial. I think that some non-economic measures are explained by this: the authorities have promised an end to intermediaries in transfers and public services, as well as a radical curtailment of strikes and protests - particularly resulting in a policy where those blocking streets would lose welfare payments. I think that, taking anti austerity protesters as rational actors, this aims to shift the calculus in favor of less disruptive modes of protest, or none at all, meaning that “social peace” would be maintained.

The nominal anchor is the only part missing. Now, it might be said that the government’s fiscal efforts should bring inflation down, but since I don’t believe in the whack-a-mole economics of Modern Monetary Theory, I don’t think the Treasury controls inflation. If the source of price changes (between real factors, such as demand, and purely nominal ones) is unknown, then prices adjust “unnecesarily”. Without clear indications of where prices are headed, the “bias” is in favor of “higher”: if I raise prices, then I might be ahead; but if I don’t, then I might lose out. In higher and higher inflation rates, pricing decisions have to be made faster, and under higher uncertainty, meaning that the price level has very high and very fast inertia: once inflation breaches a certain point, it won’t come back down from it. In fact, if the authorities ignore inertia, then prices won’t deccelerate and will remain in the 15-20% monthly rate for an indefinite period.

What kind of nominal anchor can the government use? Well, normally it’s the exchange rate: after a large initial jump, it is held down for a prolonged period, resulting in real appreciation but a clear path forward for prices. Even when the devaluation does have a direct impact on prices (and it normally doesn’t), the power the nominal FX has over expectations means it can be trusted to control prices. The initial FX overshoot is a classic feature of stabilization programs, with one large caveat: once the FX becomes overvalued, it quickly starts harming the rest of the economy.

I’m not really sure what the government’s preferred stabilization tool is (and dollarization isn’t ruled out in principle, but rather, by reality⁴) but the “Chainsaw Plan” needs to find one fast, because the demand for cash crashes in February, and the Omnibus Bill vote is on late January - if both the monetary and political planks flounder, the economic situation will quickly spiral.

Stabilizing the short-term macroeconomy is a necessary condition for another major issue, long-term growth. The country has not had real growth since 2011, meaning something must be wrong besides the price level. Milei’s diagnostic, that it’s taxes and regulation, has some manner of backing: Argentina does seem overregulated just in general. Thus, most of the program is destined to reducing the constraints on private activity across the economy, particularly in price-setting, the labor market, and international trade. Overall, the reform efforts seems like promising but tastes like little, although it is just getting started (per the architect of the reforms).

Conclusion

So, what is he doing? The dirty work, mainly, plus some weird stuff like adding strange pro-life language to regulations regarding pregnancy.

Is it enough? No, not really, on any fronts. Ignoring the long-term stuff, the government needs to come up with a monetary program ASAP, since by the measure of “how long do economic decisions plan ahead”, the economy is already in hyperinflation (i.e. plans are for under a month). Instead of the famous “second semester” from eight years ago, we’re talking about February as the end-all of macroeconomic management. So time is of the essence here.

It was also my birthday yesterday!

1. It’s not really clear what a plesbicite would be like, other than it would be non-binding and it has certain topics that are off limits. But Congress has sole attribution over the matters on which a plesbicite can be about. Also some referenda have restrictions on topic (cannot be about constitutional, international, tax, budget, or criminal matters), but it’s not clear whether those apply to plesbicites directly. The only real precedent here is a nonbinding referendum in 1984 surrounding an international treaty with Chile, making the matter even more confusing because international treaties are explicitly singled out - but maybe for non-binding matters only? Though of course, a non binding referendum would be pointless.

2. At least we can bring back some of the stupid 2018 macro memes if we bring back the 2018 macro team

3. The name comes from the fact that the IMF and the government agreed on a controlled float, 0% primary deficit, and 0% monetary base growth, which was considered “blunt” as an instrument.

4. The problems previously mentioned, i.e. actually getting 40 billion USD, are still there.