The new government's economic policy has been the subject of much criticism in recent months. However, there is one in particular that is heard a lot: Argentina has become too expensive in dollars, and therefore the current pace of devaluation is unsustainable.
The logic behind this is simple, and corresponds to what in economic theory is called the "balance of payments elasticity approach". In essence, this theory draws a direct line between a rising cost of the economy vis-à-vis the rest of the world, and problems in the external accounts. The idea is that such a rise in prices generates 2 things; on the one hand, our consumption of goods produced in the rest of the world increases (since they become relatively cheaper) and both residents and non-residents demand less locally produced goods, which depresses the levels of economic activity. Ultimately, imports will increase, exports will fall, and consequently the country's trade balance and current account (which is nothing more than the sum of the trade balance and the income derived from our transactions with foreigners) will worsen. If this imbalance persists long enough, and there is no flow of foreign capital inflows to finance it, we will have an imbalance between the dollars entering and leaving the economy, we will lose reserves, and eventually we will suffer an episode of deterioration in expectations and exchange rate volatility.
The elasticity approach then understands the trade balance result as a function of the real exchange rate (that is, how expensive we are relative to the rest of the world), and it seems to be predominant among Argentines; it is the one most often preached, and the one most frequently used to explain the external crises that plague our recent history. Of course, looking back at the past, the correlation is clear; from the failure of the Martinez de Hoz plank, to the external crisis of the Macri era, through the implosion of convertibility, we always find important appreciations of the real exchange rate that precede the collapse of these programs.
This is the logic that today leads so many colleagues to argue that it is dangerous to maintain a 2% monthly depreciation after the inflationary flash that we have experienced in recent months; in a short time, inflation will have practically equaled the devaluation accumulated since the new government took office, and we will be "behind" again. It is then argued that in order to recover the competitiveness of our exports, and avoid a new episode of backwardness and loss of reserves, it is necessary to readjust the exchange rate. These are the premises and conclusions that today are entrenched.
However, there are other approaches to understanding the fluctuations of a country's external accounts, which have been established in academia for decades as the most generally accepted: the absorption approach, and the monetary approach to the balance of payments. Each is essentially based on an accounting identity. The absorption approach tells us that the current account result is nothing more than the difference between income and expenditure at the aggregate level of the economy. The monetary approach, on the other hand, looks beyond the current account balance; it tells us that when the central bank injects more money into the economy than the public wants to keep on its balance sheet, then that surplus will reflect a loss of foreign reserves (unless there are restrictions on the capital market, in which case it will be seen as a little bit in lost reserves, and a little bit in increased domestic gap and inflation). Armed with these two accounting identities, one can understand from a different perspective the recurrent external crises we have suffered.
Historically, we have had cycles of increased foreign currency flows into the country, whether due to better terms of trade, a relaxation in global financing conditions, or a mixture of various factors. These flows allowed us to finance an expansion in aggregate demand, both in the public and private sectors (although we know that the main spender has always been the same), generating a deterioration in the current account. Of course, in these cycles the demand for domestic goods and services also increases, which boosts economic growth, but also puts upward pressure on prices; given an exchange rate that we try to keep relatively stable, this leads to an increase in the cost of the economy measured in dollars, or what amounts to the same thing, an appreciation of the real exchange rate.
When external conditions change or there is a loss of confidence in the sustainability of the program for whatever reason, the capital flows that financed the imbalance between revenues and expenditures begin to reverse. Public demand for peso assets deteriorates, and given the usual reluctance of the political class to adjust its spending to the new financing conditions, the deficit and issuance continue. This results in a widening gap between the pesos injected into the market and the pesos the market wants to hold, leading to a loss of reserves. Eventually, we devalue the currency, amid a deep deterioration in expectations, and see the current account improve. Automatically, we attribute the reestablishment of the external balance to the cheapening of the economy in dollars, and the recovery of the competitiveness of our exports. However, history shows that these adjustments are mainly due to the sharp deterioration of imports due to the recession and the contraction of aggregate demand, while exports recover only marginally. The real origin of the external crises has always been the same; overspending and inefficient spending when the world financed us, without worrying about being prepared for when it stopped. The devaluation jumps are a tool to socialize the adjustment of accounts resisted by a particular sector.
The convertibility crisis is a clear example of Argentina's obsession with the real exchange rate. There will be no lack of economists who will argue that the years of strong recession that preceded the fall of the program were due to the exchange rate backwardness generated by the fixed exchange rate. That would indicate the elasticities approach. However, a more complete view of the conjuncture allows us to understand the crisis in another way. Prior to the beginning of the fall in activity, both local and foreign analysts were already predicting the unsustainability of the exchange rate scheme. The current account deficit was not seen simply as the counterpart of external investors' financing, but as evidence of the need to recover competitiveness vis-à-vis the rest of the world. The financial crisis in Russia and the devaluation of the Brazilian real at the end of the century accentuated these criticisms, and all this contributed to the fact that net capital inflows to the country began to fall dramatically. This forced the public sector to internally finance an increasing portion of its fiscal deficit, which resulted in a drop in credit to the private sector. It is in this context that a fall in aggregate demand and employment was consolidated, which had nothing to do with the competitiveness of Argentine exports. Conditions changed, and the economy was automatically forced to tighten its belt. This is how the current account went from a deficit of more than 16 billion dollars in 1998 to a surplus at the end of 2001, before any jump in the exchange rate.
This government's economic plan has two stages, one of stabilization and one of structural reforms that should underpin long-term growth. The stabilization phase is based on three fundamental pillars. The first two are fiscal adjustment and monetary adjustment. The absorption approach tells us that in an economy in which the public sector eliminates the deficit, and the private sector is also, at least initially, forced to adjust its expenditures, while the agricultural and energy sectors boost revenues, the current account will be in surplus. The monetary approach tells us that by sharply liquefying the real value of the public's peso holdings and bringing issuance to zero, any market replenishment of these holdings will have to take place via foreign exchange sales to the central bank. It is in this context, in which the peso has become a scarce commodity for the first time in recent memory, that the strong accumulation of reserves in recent months, as well as the rapid compression of the gap, should be understood. There are of course those who argue that this is explained thanks to the cepo, and the fact that 20% of export settlements are made in the CCL market. If this is the explanation, it is curious that under the same conditions the previous administration faced an unstoppable loss of reserves, and an exchange rate gap that reached 180%. It is a conceptual error to consider that in an economy without pesos and with depressed aggregate demand the only thing that is preventing a jump in the demand for dollars and a loss of reserves are the exchange restrictions.
The third and last leg that supports stabilization is undoubtedly the exchange rate anchor, of course endowed with credibility thanks to the 2 legs already mentioned. With the exception of the episode of the exit from convertibility, all the devaluation jumps that were applied with the objective of "correcting the exchange rate backwardness" were passed on at a greater or lesser speed almost entirely to prices within the following 12 months. Argentina has only managed to be significantly cheaper than at present in the midst of strong volatility and capital outflows. History teaches us that in an economy without its own currency, devaluations do little more than generate capital losses and trigger a new round of price adjustments. If competitiveness were achieved through devaluation leaps, by now we would be the most competitive country in the world. The Milei plan may have its questions, but it should be clear that the exchange rate backwardness should not be one of them, and that it is not a calibration of the real exchange rate that will save us from external crises in the future. At this stage, the accumulation of reserves will essentially depend on the ability of this administration to maintain fiscal and monetary discipline. A larger cushion of reserves will gradually allow the lifting of exchange restrictions with greater security, and from here is where structural reforms will have to come into play, aiming primarily at an opening of the economy, a labor reform and a reduction in the tax burden. These reforms, together with the cheapening of credit resulting from the drop in country risk, will improve Argentina's competitiveness in a much more profound and sustainable way than any devaluation jump.
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