The Financial Times reports in an interesting article on the Argentine currency strategy. Apparently, President Javier Milei has decided to focus on the so-called anchor approach in the fight against inflation. An anchor approach means that you try to manage your own currency against a stable currency such as the US dollar in such a way that the depreciation of your own currency is significantly lower than the inflation differential with the anchor country. So far, there has been a monthly depreciation of two per cent, which was not enough to offset the inflation differential, but now the depreciation rate is to be reduced to only one per cent per month.
Anyone who has been dealing with international currency issues for a long time experiences a lot of déjà vu. At the beginning of the 1990s, Brazil tried to stabilize its new currency, the real, internally and externally with exactly such an approach. It was called a crawling peg, but it was a deliberately slow crawl because the inflation differential with other countries was not fully equalized; instead, the currency was devalued less than the inflation differential. This resulted in a real appreciation of the domestic currency. The idea behind it was that cheap imports would put pressure on the domestic economy to raise domestic prices less. They tried, so to speak, to import a bit of price stability through this monetary policy. Argentina went a step further at the time: it pegged its peso 1:1 to the US dollar (which had the same effect as the Brazilian crawling peg, only more radically and quickly) and promised its citizens that this was a ‘fixing forever’ or a ‘fixing for your lifetime’. Both countries had opted for this approach after a long experience of inflation because they no longer saw any possibility of curbing inflation with domestic restrictive policy.
The Argentinean eternity
We know that the Argentinean eternity did not last ten years. The ensuing crisis brought the country to the brink of political collapse in 2002. The Brazilian experiment also ended with a big bang as early as 1999.
The International Monetary Fund (IMF) had explicitly approved of these approaches at the time. It recommended the so-called corner solutions, i.e. absolutely fixed or completely flexible exchange rates (see my UNCTAD paper from 2001). However, the IMF did not tell the countries what the one corner, namely that of the anchor approach, implied: an ever-increasing overvaluation of the domestic currency and massively rising current account deficits, and finally a currency crisis with a huge devaluation, because at some point ‘international investors’ suddenly withdraw from the country. Anyone who only imports but no longer exports loses the ‘trust’ of these investors, even if they are libertarians.
The biggest failure of the IMF and the governments supporting it, however, was not to provide the affected countries with reasonable support when the crisis broke out[1]. If you don’t have international protection in the event of a crisis, the anchor approach is a form of delayed hara-kiri.
A solution à la Don Quixote
As president of Argentina, one should know all of this. But Javier Milei, who bases his economic knowledge primarily on libertarian authors and those who belong to the Austrian school, is lost. He can now pore over neoliberal or libertarian textbooks or call all of his friends at the Ludwig von Mises Institute, but he won’t learn anything useful. Even the starting point means a aggregated view for a true ‘Austrian’, which he cannot use. Currency problems simply do not exist in the ‘school’ because markets cannot err. They have no theory of inflation and certainly no currency theory. Additionally, they refuse to deal with quantitative problems at all.
But Milei has, nevertheless, found an ‘Austrian solution’, as reported in the Financial Times. He wants to restore the country’s competitiveness without devaluation by deregulating, lowering taxes and making it easier for companies to borrow. Well, good luck with that. Wanting to combat a real appreciation, which will be in the region of 50 per cent or more in one to two years (calculated against today’s rate), with deregulation is only comparable to the brave fight of the Spanish knight Don Quixote, who charged at windmills with his sword.
I’ll make a bold prediction: a major crisis and a huge devaluation of the Argentine peso are inevitable. If I were a gambler, I would now go into debt in Argentine pesos in the long term, because those debts, expressed in US dollars, will melt away like snow in the Argentine sun as soon as the big devaluation comes. In the meantime, a good gambler can also make a lot of money by investing their money in Argentina at very short notice as soon as they realize that the now low rate of devaluation no longer eats up the interest rate difference between Argentina and the US.
The Financial Times also mentions this in a half-sentence: ‘Milei has described slowing the devaluation as an important step on the road to removing Argentina’s strict currency and capital controls, a top concern for foreign investors, which he has pledged to do in 2025.’ Exactly, currency and capital controls are a horror for “foreign investors” (translated: currency market speculators). If the inevitable adjustment of the currency to the inflation differentials vis-à-vis trading partners is postponed, they can once again reap speculative profits for quite a while, while the Argentine president will celebrate the influx of hot money (which he will no doubt call ‘foreign capital’) as proof of the confidence of ‘the financial markets’ in his policies.
In the long term as in the short term, the markets are the friend of the libertarians, who exploit the poor and uninformed as long as they can.
[1] At the time, I had proposed to the G7 deputy finance ministers that an international guarantee be used to secure the necessary devaluation in Brazil in order to avert a dramatic decline in the currency and further waves of speculation. But my American colleague Larry Summers rejected this outraged as an intervention ‘in the markets’. As a result, the Brazilian real depreciated far more than would have been necessary, plunging Brazil into a deep crisis (because you then have to raise interest rates to limit the depreciation) and putting Argentina under additional pressure.