The Economic Plan of Javier Milei
By Alejo Lasala and Franco Matías Vicchio
Inheritance and Initial Measures
As of December 2023, the quasi-fiscal deficit of the Central Bank of the Argentine Republic reached 15% of GDP. These losses are directly transferred to public debt and inflationary pressure. When the central bank accumulates debt through its operations, the government eventually has to assume it, increasing the country's financial burden: it did so through monetary issuance. On the other hand, the reserves stood at USD -11,000M, which were used for sales to contain the devaluation pressure on the peso generated by the issuance itself: if you have $1 for every USD 1 in the economy, the parity is 1-1; if now we have $2000 for every USD 1 in the same economy, the parity is now 2000-1 (this same thing happens with the price of all goods). This is why under Fernández's administration, the peso depreciated by 83.5% against the official dollar, while there was a 170% gap with the parallel dollar. Moreover, accumulated inflation over the four years closed above 900%.
The first measures of the incoming government were to narrow the exchange rate gap: that is, bring the official dollar closer to the market dollar and release frozen prices to avoid gradual future inflation, knowing of excellent electoral results and taking advantage of the initial moments of the government to implement the measures that would most affect purchasing power. At the same time, it began a systematic search to reduce the state's fiscal burdens: public spending and, therefore, the fiscal deficit. The sustained practice of high public spending and chronic fiscal deficit necessitated money issuance to finance it, turning us into one of the countries with the highest debt in the world.
In order to achieve this, they aimed to close the money issuance taps and contract the circulating bills on the street. This inevitably produced two consequences: the reduction of inflation and the drop in consumption and production: less money in people's pockets implies less leftover destined for purchases (although ultimately, it was lost in the medium term, and consumption was driven by the need to spend before everything increased in price).
Faced with this, critics and opponents described the measures as a destructive and harmful policy for the industry, or that it solved a problem by creating another more severe one. All of this was said without proposing an alternative solution to reducing inflation, of course. Or worse, asserting that "the dollar shortage" was its cause, downplaying the importance of the fiscal deficit (which is to some extent what generated this shortage under other administrations, due to the need to finance it with debt, monetary issuance, and ultimately, the loss of reserves to sustain a fictitious dollar).
But history (and common sense) shows that the shock policy adopted by the liberal government is the right one, despite the criticism. It is common sense to think, for example, that there must be fiscal balance. Contrary to the words of Cristina Fernández de Kirchner, former President (and husband) Néstor Kirchner knew this, and not just rhetorically: under his mandate, the Law of Fiscal Responsibility was sanctioned and applied, later neutralized and repealed by his spouse. It is also common sense to think that the more peso bills there are in an economy, the more inflation there will be, contrary to the thoughts and practices of former Minister Massa and former President Alberto Fernández, who faced a "war on inflation" ignoring (and using in reverse) all financial tools, under the fatal arrogance of threats and sanctions with the price control policy. Of course, they lost. Hitler, for his part, knew this clearly: he wanted to eliminate the enemy by injecting bills into their economy.
The hyperinflation of 1989
One of the most severe hyperinflation cases in the recent history of countries is our own. Carlos Saul Menem took office in 1989 in a hyperinflationary context resulting from the policies derived from the various economic plans carried out in Raúl Alfonsín's government. The economic policy guidelines of the new government adopted some of the standards established in the so-called "Washington Consensus" (omitting key aspects that would later lead to the 2001 crisis, such as having a competitive and non-fixed exchange rate, tax reform, reducing public spending, or opening trade), similar to those adopted by the current government, and, for example, very similar to the points of the May Pact. But before adopting these guidelines, the country needed a lifeboat to get out of the unsustainable economic crisis.
Before Domingo Cavallo's assumption in 1991, Menem's administration bet on a stabilization plan that would count on the support of important business sectors: the Bunge and Born Plan. The concrete measures were to devalue the commercial exchange rate by 170%, setting the dollar at 650 australes. This price was even above the quotation of the informal dollar, which at that time was around $500. With this maxi-devaluation, it was expected to absorb the residual inflation until the economy's total stabilization, as this exchange rate anchor should remain until March 1990.
Complementary to this measure, a salary increase of 8000 australes was decreed, a 900% increase in public tariffs (as in 2023, lagging behind inflation, thus providing an unsustainable service), a reduction in reserve requirements, and liberation of interest rates, along with an increase in export duties (which represented a significant income for the public sector in dollars). A price agreement was negotiated with the private sector, reached ten days after the Plan's announcement. This resulted in a progressive decline in inflation rates since combined with the exchange rate freeze, tariffs, and the reimplementation of withholdings, it determined a progressive decline in inflation rates that went from 200% in July to 5.6% in October. However, these measures began to show their exhaustion over the months, causing the exchange rate to exceed 1000 A, significantly widening the exchange gap and hiking interest rates, leading to many measures such as price agreements being quickly abolished, and withholdings being reduced.
It is in this context that the so-called Bonex Plan appears. Its purpose was to substantially reduce the stock of money in the public's hands and eliminate the short-term interest burden on public debt. The plan consisted of the forced conversion of fixed-term deposits in dollars and other forms of savings into government bonds denominated in dollars, known as "Bonex 89". Fixed-term dollar deposits and other forms of bank savings were compulsorily converted into Bonex bonds with a ten-year maturity. The consequence of this was that savers who had their deposits converted into bonds lost immediate liquidity, as the Bonex bonds had long maturities and their market value was lower than the original deposits. Although the plan managed to temporarily reduce inflation and pressure on the Argentine peso, it had a significant social and economic cost due to the weak principle of private property. Many savers felt defrauded, and trust in the banking system and the government's economic policies deteriorated.
Experience shows us how difficult and unpopular measures were taken to get out of the crisis, such as the abrupt update of tariffs, the devaluation of the exchange rate, or the implementation of the Bonex Plan. However, stopping the inflationary inertia laid the foundations to, from 1991, carry out the convertibility law and economic reform (privatizations, aiming to generate liquidity and reduce the deficit, besides the deregulation of the economy) to achieve stability.
Shimon Peres and the Israeli Miracle
From the 1970s and until the mid-1980s, in a context aggravated by the Yom Kippur War and the oil crisis, Israel was involved in hyperinflation reaching peaks of 500% in the early '80s. The diagnosis was complicated: public expenditure at 76% of GDP, a fiscal deficit of almost 20 points, and its financing was mainly the issuance of unsupported money. External debt, in turn, doubled GDP, and there were no longer dollar reserves to address it. How did they solve it?
In 1985, Shimon Peres called a cabinet meeting with a clear objective, in his own words: “either you accept the spending cuts, or I will fire you all.” He slashed $500 million in defense spending (the largest in Israel's history), even in areas such as education, which meant the end of his friendship with the Minister. “All ministers accepted cuts in other areas; none wanted to cut their own ministry,” affirmed the former leader. This policy was accompanied by a strong devaluation and a freeze on the exchange rate and, momentarily, certain prices in the economy. This shock plan applied in Israel had, in the short term, certain implications for employment, consumption, industry, and GDP. In 1985, Israel's GDP grew at a rate of 3.1%. In 1986, after the plan's implementation, GDP growth significantly slowed, registering a 1.6% growth. Unemployment initially increased due to economic contraction. The unemployment rate went up from 6.9% in 1984 to 7.8% in 1986 and continued to rise slightly in the following years.
Other shock stabilization plans in public spending, fiscal deficit, monetary contraction, and devaluation to mention:
Germany (1921). In November 1923, Germany introduced a new currency, the Rentenmark, to replace the depreciated Papiermark, which restored confidence. Additionally, the Rentenbank was created, an independent central bank responsible for issuing the new currency and maintaining monetary stability. This government independence was crucial to restoring confidence in monetary policy.
Argentina (1959). “We have to get through the winter.” There was a cut of 70,000 public employees. The level of monetary contraction had to be so great, similar to today, that it reached the point of recession in economic activity, and GDP fell by 6.5%. In the following years, it recovered and grew by around 8%.
Conclusions
A stabilization plan, by definition, involves reversing an inherited crisis. The same, in a hyperinflationary scenario and with a patched economy, where prices are frozen/delayed under state intervention (and consequently also poverty, employment, and inequality indices artificially maintained) added to the magnitude of the macroeconomic overflow, requires initial unpopular measures that will probably affect consumption and, therefore, industry, and growth at least in the short term.
Focusing the discussion on the negative short-term consequences of the stabilization aspect, such as criticizing the devaluation by the liberal government assumed in 2023, implies a profound misunderstanding of how a normal economy works and the inherited macroeconomic indices. Without the normalization of prices, which function through an information system provided by the free market (supply and demand, producers and consumers), whether at the cost of inflationary intervention via monetary issuance, price controls, or the absurd decision to implement both simultaneously (like oil and water), it is impossible to expect economic growth. Hence, the term “stagflation” emerged almost a century ago: inflation + economic stagnation.
The discourses that deny the importance of fiscal balance are functional to a populist politicization of the economy, which authors Rudiger Dornbusch and Sebastián Edwards described in 1990 as the underestimation of the consequences of deficit financing. The denial of the importance of a coherent and sustainable economic policy that is only now in political discussion has been underestimated for most of our history. This has led to 70 years of fiscal deficit. Under the populist mask of income redistribution, a politicized economic model was sustained that hindered wealth creation and has led to one in two Argentinians being poor.
If Javier Milei's government's adjustment policy manages to generate normal conditions in the short term, starting with the gradual lifting of the exchange rate ceiling, lowering inflation, and a progressive uptick in consumption and industry, and considering the context in which he was elected, it is possible to begin to glimpse that a new era has started in our country's politics, where the model of macroeconomic populism may have clashed with the statist cultural model, and this could explain the shift in the ideological spectrum of political discussion in Argentina in recent months. It is still early, but the economy for Milei could be what security was for Bukele, especially considering the next elections.
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