Argentina: A Monetary Crisis With Contagion Risks
By Daniel Lacalle
- Argentina has ignored the rising fiscal and monetary imbalances for many years.
- Risk for investors is that any likely government will continue with same policies.
- Other emerging markets face similar risks.
The Argentine crisis should alert governments and investors against the temptation of disguising structural problems with timid adjustments and monetary imbalances.
Gradualism did not solve structural problems and the peso collapsed even more in fear of returning to the monetary and confiscatory policies of the Kirchner era.
Argentina also shows us that risk builds slowly and happens fast.
How did we get here?
In 10 years, Argentina increased the money supply by 1,200% to finance growing political spending. Argentina suffers the highest tax wedge in the region and one of the highest for companies in the world, while the enormous inflation and depreciation of the peso represent strong barriers to investment, growth and job creation. With public spending that exceeds 45% of GDP, it is not only the highest in the region, but also the most inefficient according to the Inter-American Development Bank. Primary public spending as a percentage of GDP shot up from 23.6% in 2004 to 45% in 2018 and the public sector workforce multiplied to reach 26% of the total. The inefficiency of public spending in Argentina reaches 7.2% of GDP. With interventionist policies, the global competitiveness index of the World Economic Forum shows Argentina ranked 92 out of 137 countries. All this was financed with the highest money supply growth in the region after Venezuela.
It is not easy to change the wrong policies rapidly and effectively without recognizing the huge monetary and fiscal hole created in the previous administration. If reforms are not decisive and meaningful, the Argentine economy will continue being more fragile and vulnerable to economic cycles than others. A massive fiscal and monetary gap designed and activated by the previous administration exploded in Mauricio Macri’s government’s face, and the timid reforms were not enough to avoid another crisis. Now the currency collapses at the risk of returning to the uncontrolled printing of currency and interventionist policies.
The logic behind gradualism and timid reforms came from misguided expectations of a weakening US dollar and rising capital inflows to compensate for the monetary imbalances of the economy. It was a huge mistake in Argentina, especially because the history of devaluations, defaults and bank runs in the country proves that the country tends to avoid significant reforms in favour of drastic and harmful measures.
Why did Argentina not issue debt in local currency instead of US-dollar denominated bonds?
Not because it did not want to or did not listen to the magic solutions of Modern Monetary Theory proponents, but for a very simple reason: There was virtually no demand either from domestic or international investors. Almost no one wants currency risk when there is almost full certainty that governments will decide to devalue and destroy the purchasing power of the currency.
Argentina may be a case of extreme risk, but is also an example of how investors forget history and ignore risk. Argentina issued a 100-year bond in US dollars with a 7.8% yield in 2017. It was oversubscribed. Now the country faces another default risk.
Argentina may be one of the riskiest examples of the decision to ignore fundamental risks due to the massive monetary stimuli of recent years, but the problems are also evident in other emerging markets, albeit at less extreme levels.
Emerging market economies increased their debt US dollar-denominated issuances in the past eight years and face 1.2 trillion dollars of maturities to 2025, according to the IIF. Similar to Argentina’s case, a significant proportion of that debt was issued on the back of rising global liquidity and cheap US dollars. Now, many of these countries face rising maturities combined with weakening economic growth and inflation expectations as well as declining US-dollar revenues from exports due to the global slowdown and moderate commodity prices. Global demand for bonds and the search for yield may help refinance these maturities, and foreign exchange reserves remain acceptable, but the risks are rising and yields are not reflecting the increased uncertainties and solvency concerns.
Like Turkey before, Argentina shows us the flaws of the Modern Monetary Theory in reality. Countries cannot issue all the currency their governments need nor issue all the debt they want in domestic currency when there is no real demand for that currency. Argentina should not be ignored by other countries as an anomaly, but as a red flag.
Winter is coming, and rising imbalances do not strengthen the economy.