WTF is going on with the Economy?!

WTF is going on with the Economy?! #120 - Is Argentina at an inflection point?

WTF Economy Editors February 27 2024 · 6 min read

There’s a famous saying that goes:

There are four types of countries in the world: advanced, developing, Japan, and Argentina.

We can dive into Japan in a later edition (please let me know if you want us to cover this!), but Argentina’s unique economy has been the study of economists for nearly four decades. With the election of Javier Milei, another chapter is being written in this South American powerhouse’s economic history book. We’ll quickly look at why many are now paying attention and what it could mean for one of the largest economies in the Southern Hemisphere.

(Editor’s note: we’re aware that many of Mr. Milei positions are controversial, particularly on social issues. We’re only exploring the economic side of his policies). 

How did Argentina wind up in this situation? 

Argentina’s history is anything but boring, and the story of its economy is no different. Since the 1950s, the country has gone through 14 recessions, with a ratio of one year of economic contraction for every two years of growth. This economic instability has resulted in or contributed to:

  • political volatility
  • near-zero real growth (as the country’s GDP isn’t much better than it was in 1974)
  • periods of hyperinflation
  • nationalizations of large parts of the economy
  • numerous bailouts of the economy by lenders with the country owing 44.5 billion USD to international institutions.

These factors have all played a part in creating a vicious cycle of economic disruption, where one action or factor would accelerate another. For example, the government would borrow money from foreign creditors and spend it to boost the economy or invest in a political pet project, taking out loans in dollars. However, it would also devalue its currency (the peso) to make exports more competitive.  

Devaluing the currency had two impacts:

  • It made imports more expensive which increased inflation 
  • It forced the government to tax citizens and companies more to repay the dollar-denominated loans, to make up for the bigger difference in the weakened exchange rate.

As this cycle continued, the policymakers had three choices:

  1. Keep raising taxes and devaluing the currency hoping to hit the balance between economic performance and covering debt.
  2. Cut spending to pay off the balance on loans.
  3. Don’t repay debt and default, knowing that lenders will charge higher rates with stricter conditions in the future.

Policially, the second option was the hardest to swallow since it meant job losses and a recession, leaving successive governments to pursue the first and last options. The government would try to stabilize the peso by setting official exchanges, with little success as the market forces determined another unofficial and far weaker one, used by most people and companies to conduct business.

Regardless, no government has been able to stabilize the economy and change its trajectory for the better. By the end of last year, voters decided that they were willing to take a radical new approach to breaking this destructive cycle.

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Why might things change now? 

In late 2023, Argentines elected a political outsider and self-described “anarcho-capitalist” Javier Milei as president. Mr. Milei has long been critical of the mismanagement of the economy, parlaying that grievance into the core of his presidential campaign. During his run, he stated that as president he would:

  • radically cut spending
  • private many parts of the economy that were under government control 
  • devalue the peso so that it would match the real exchange rate used by businesses and street traders
  • strongly consider replacing the peso with the US dollar

After winning office, he set out to implement his ambitious plan, with the goal to eliminate deficits, pay off debt, tame inflation, and reset the economy.

While it’s too early to tell if his tactics will work (Mr. Milei only started his term in December of 2023), they represent a significant change from any of his predecessors.

What could this mean for the future? 

Argentina is one of the largest countries in South America. With deep ties to Europe, the country can play a vital role in the South American economy while reaching economic potential many believe it is capable of.

For example, stabilizing the currency and creating better lending conditions could help the government finance infrastructure projects that increase economic output and reduce reliance on imports. That would enable producers in the economy to focus on growing exports to wealthier markets, like the EU (although as we wrote about in our last issue, that might be easier said than done).

Argentina could even keep its currency if it can stabilize it. While replacing the peso with the dollar might bring stability, it also takes away monetary flexibility. (Central banks can control their economy with interest rates and the cost of borrowing money. If Argentina gives up the peso for the US dollar, then they’ll lose that ability). Having responsible control of the currency will enable policymakers in Buenos Aires to make growth adjustments when they see fit.

Right now, it’s too soon to tell if these reforms will work. Argentina’s historical track record means the odds aren’t in Mr. Milei’s favor. However, we’re watching a break with the past, which if anything, is exciting (for us economics nerds at least), and could represent a model for other countries who have or are at risk of falling down a similar trap.