There’s a country that always, always, always appears in the headlines of international
newspapers for two main reasons: soccer and economic crises.
The problem, my friends, is that lately, these headlines are having more to do with crises
than with football
Of course, I’m talking about Argentina.
This is hard to say, but Argentina is a country that seems as allergic to reforms as it is
addicted to crises.
When everything seemed to be going well, 2018 suddenly became very complicated-- so much
so that Mauricio Macri’s government has been forced to ask for a "bailout" from the
International Monetary Fund.
Wait, a bailout?
In Argentina?
Again?
Well, yes... you heard that right.
Argentina, the country of tango is back on the ropes.
Listen up.
April and May of 2018 haven’t precisely been good months for Argentina.
In just a few weeks, the peso was depreciated by 20%, going from an exchange rate of 1 US
dollar for 20 pesos to a 1 US dollar for 25 pesos.
But...
You know what?
This isn’t surprising.
Since the beginning of 2018, Argentina’s currency has depreciated by 25%...
And we extended the time to the last 5 years... could you tell me how much the Argentine peso
depreciated?
Well... by no less than 80%.
Now, make no mistake, the plummeting exchange rate isn’t the problem... but the consequence.
See, my friends, Argentina’s real problem lies in its addiction to public spending…
And I’m not saying that public spending is slightly higher than they can afford…
they have such a high public spending rate that Argentina simply cannot afford it.
(AUDIO: “In the last 57 years, we’ve spent 53 years with the State spending more than
they collect, that is with a fiscal deficit, during those 53 years we had 4 huge crises.
Now we’re fighting to avoid a fifth one”.- José Luis Espert, economist and author of
the book “The Devoured Argentina”)
But... wait a second…
I know what you may be thinking...
Simon, what the hell does public spending have to do with the peso’s depreciation?
Well... much more than you think.
Let’s go through it step by step.
Argentina is facing a triple time bomb: it has a huge external deficit, a huge public
deficit and 250 billion dollars of external debt.
Of course, as you can imagine... both the deficit and debt have to be paid...
And here’s where the first big problem appears:
Years and years of protectionism, devaluations, hyper regulation and very high taxes – Because
Argentina is one of the countries with the highest business taxes on the entire planet--All
of this has stopped the industry, and the Argentine economy in general, from being competitive...
and has caused capitalists to flee the country long ago in search of refuge.
Sounds logical, right?
Well, the result?
Since there’s no "money" at home...
Argentina has become very dependent on foreign financing.
According to the Institute of International Finance, most, almost 64% of Argentina’s
state and corporate debt is denominated in dollars and other foreign currencies.
That’s why both the volume of Central Bank reserves and the exchange rate are very, very
important.
Of course, on the one hand, they need to pay for imports and deal with debt payments...
But... since Argentina has a negative external balance--that is, it consumes more dollars
than it gets... it needs someone to lend them those dollars.
It needs investors to bring money to the country.
And, my friends, if investors don’t lend that money because they don’t trust the
country… then Argentina has a problem, a huge problem.
On the other hand, if the peso depreciates then... obviously, it loses value... and,
folks, let's be honest, nobody wants to have their savings in a currency that devalues
so quickly...
What do you do in that situation?
Well, you rush to exchange all your pesos for a “stronger” and more “stable”
currency…
And that’s exactly what Argentines are doing, which is causing the peso to collapse even
more... and for the reserves to be consumed much faster.
But... okay, having said this.
Let's take a look at the government.
See, both Néstor Kirchner and especially Cristina Fernández de Kirchner, the two previous
presidents of Argentina, they liked to spend quite freely...
When they came to power in 2002, public spending was equivalent to 23% of the GDP, when they
left... it was more than 40%.
But you’re surely wondering... what did they do with all that money?
Well basically... they hired public employees - To win votes, you know - and multiplied
subsidies.
Thus, for example, in only 13 years, public employment soared by 60%.
To give you an idea of how extreme this was,
today 35% of Argentine employees work for the goverment.
And get this.
In seven provinces there are even more public workers than private workers.
Crazy!
And of course, my friends, given that the government didn’t have enough money to pay
for all this well... year after year they registered a huge public deficit.
However... as you may know... the Kirchners couldn’t go to the international markets,
first because their investors didn’t trust them, and second because the country was already
in default…
And, of course, if you don’t pay, obviously, investors don’t lend you money again.
So, what do you think they did?
Exactly!
They used every populist politician’s favorite machine: the money printing machine to pay
public expenditures with new pesos.
That and establishing a currency cap, which means limiting the amount of money that Argentines
could take out of the country... so they wouldn’t eat up their dwindling reserves.
And the question is, what happens when these policies continue?
Well... inflation soars due to all the new pesos in circulation... and foreign investors,
of course, don’t want to come near you.
And so, it was in these circumstances that Mauricio Macri came to power.
(THE MACRI PLAN)
When Mauricio Macri came to the Casa Rosada he had a plan: to implement reforms
little by little... commonly known as gradualism…
And the truth is that they’ve been quite successful:
the business climate has been improved, some subsidies have been reduced and, in a way,
they regained the international investors’ trust.
But... out of all the hard things they needed to do, they’ve only done the easiest ones.
What they haven’t achieved in more than two years of governing, has been decreasing
the public deficit or inflation.
And in spite of having access to the financial markets, the Argentine government has continued
to print bills to maintain their huge public expenditure... and that of course means more
inflation.
This chart shows how the money is growing, that is, how the Central Bank of the Republic
of Argentina continues to issue more and more pesos.
But... okay, you may be wondering, wasn’t Mauricio Macri supposed to change things?
Yes... but slowly.
See, this all has an explanation.
Macri's team’s idea was to carry out reforms little by little, to attract investments and
make the Argentine economy grow.
If the economy grew, the government would raise more money and wouldn't have to make
cuts.
Meanwhile, little by little, as they regained the international markets’ trust, they would
be able to issue a debt and thus reduce the need to print bills.
In this way, within a few years Argentina would get rid of their deficit, inflation
and would grow again.
And Macri, of course, would maintain his political capital to continue winning elections.
Sounds good, right?
Well, so far, more or less, things have gone as planned.
But just a moment, because that has now changed, mainly for two reasons.
First... after two and a half years in power, it’s hard to understand how the public deficit,
inflation and taxes continue to skyrocket... gradualism has become something like racing
a turtle with rheumatism.
And second... because the Federal Reserve of the United States has begun to raise interests.
See, for public debt in the United States, a 10-year bond is already yielding 3%...
And of course many investors now ask themselves:
If the US debt, which is supposedly the less risky asset, gives me a reasonable return,
why on earth would I risk lending my money to Argentina, where I see no changes?
Well... that’s exactly what has caused many capitals which had begun to show interest
in Argentina, to turn around.
And for this reason...
Macri’s government has decided to resort to the International Monetary Fund to obtain
a credit line with which to face the debt maturities of the upcoming months and the
future.... lest investors no longer want to put more money on the table.
Can you imagine if a new default occurred before the 2019 elections?
See?
Everything has to do with the government’s behavior.
And if you think about it for a moment, it's very sensible.
The patience once held for Argentina is gone.
What investors and Argentine savers themselves say is..
“Fine!
If you want to spend more than you can, good for you, but not with my money”.
And not only in regard to public spending, but many other reforms that make it easier
to do business.
And this brings up a key question...
Is it time to abandon gradualism?
(AGGRESSIVE THERAPIES OR GRADUALISM?)
Folks, making reforms is never easy... but I think it’s time for the Casa Rosada - the
Argentinian White House - to ask itself a question.
Shouldn’t they try employing more aggressive measures?
Well... you know what?
First let’s take a look at the historical evidence.
Which do you think has worked better, gradualism, a calm, step-by-step change, or aggressive
therapy?
Well... we can see a good example of huge transformations in the former countries of
the Soviet orbit.
When the communist model collapsed in 1989, many countries employed drastic changes, almost
overnight, while others opted for more gradual measures.
And you know who had the best results?
Yes, the ones that made the most reforms.
Countries such as Estonia, Latvia, Lithuania, Poland and the Czech Republic opted for a
more drastic change, that is, making reforms as quickly as possible.
And yes, it was hard at the beginning, but soon they began to grow and achieved all kinds
of investments, to such an extent that today these countries, which were mostly poor in
1989, have a higher living standard than Portugal or any other Latin American country.
On the other hand, those who applied gradual reforms... countries such as Ukraine, Romania,
Tajikistan and Armenia... let’s say, things haven’t gone so well, neither in economic
nor in social terms.
Anyway... folks, this is the decision that Macri’s government has to make.
Whether or not to take advantage of the IMF's money to carry out strong reforms once and
for all...
And let's be clear, if Argentina doesn’t fix its public deficit and stops printing
bills, the future doesn’t look very good for them.
“Borrowing money isn’t good governance.”
“Good governance is creating basic reforms: in Argentina there’s an elephantine, gigantic,
hypertrophied state that needs to slim down.
They need to cut public spending.”
- Jaime Bayly.
In addition, the model simply doesn’t work: the Argentine government had never spent so
much, and despite that, it’s been decades since there was so much poverty and so much
violence.
Will Macri listen?
Only the future will tell.
But now it's your turn: What do you think?
Should they continue with the gradual reforms or is it time for a faster change?
Leave your answer in the comments as well as in this servey.