Argentina is on the verge of radical change. The country’s newly elected leader – who has been nicknamed “the Madman” has vowed to close the central bank, shut down multiple government departments, do away with the national currency and privatize industry. Markets have rallied since his win, but can Milei implement the changes he has campaigned on, and do they make sense for Argentina?
Milei is a surprising candidate – some of the press are describing him as being “like Trump” and as “Far Right.” He is definitely an unusual candidate, having campaigned with a chainsaw saying that he will chainsaw government spending and regulation [Clip Saw]. He has smashed up Styrofoam effigies of the central bank on the campaign trail [clip] He says that he will close multiple government departments [clip] He has a superhero alter ego called General Ancap [Clip] and he says that he will dollarize the economy.
The Argentinian economy is a basket case. Once one of the richest countries in the world, persistent economic mismanagement has meant that the IMF have had to visit 22 times since 1958. Argentina is by far the IMF’s top debtor. 40 percent of the population live in poverty, interest rates and inflation are above 140%. Only Venezuela and Lebanon have higher inflation. Argentina has defaulted three times since 2000 and a lender famously seized an Argentinian navy ship in 2012 as partial repayment for loans. In the past four years, the value of the Argentine peso has fallen by more than ninety per cent against the U.S. dollar.
Milei, a self-described “anarcho-capitalist”, won the election with some showmanship and an economic campaign. He stirred up controversy, suggesting legalizing the sale of human organs and eliminating all gun laws. He referred to China, (Argentina’s second largest trading partner), as “murderous”, the Argentine Pope Francis as “a filthy leftist” and climate change as “a socialist hoax”.
Polls showed that many of Milei’s wilder ideas, like allowing the sale of human organs, were unpopular with the people, but they did draw attention to him. What the people liked was his appeal to reject the entire political class, which has failed voters consistently since the nation returned to democracy in 1983.
Milei’s claims that a privileged “caste” of politicians steals from ordinary people and he has some pretty good evidence to back that up… Last year the current vice-president – and former president of Argentina, Cristina Fernández de Kirchner, was convicted in a billion-dollar fraud case - she (of course) denies wrongdoing.
While the world has being paying attention to Milei’s colorful behavior, many Argentinians are saying that the voted for him not because of his fiery rhetoric, but in spite of it. The win for Milei, is a rebuke for Argentina’s Peronist movement, which has dominated politics since the country returned to democracy in 1983. Over the last twenty years, left-leaning Peronist governments have doubled the size of the public sector and introduced expensive subsidies and tight regulation choking the economy.
While the media have been describing Milei as being Argentina’s Donald Trump, other than the showmanship and distinctive hairstyles the two have very little in common. Both men have spoken well of each other, and Milei says that he sees Trump as part of the fight against socialism. Milei, like Trump, is an outsider to politics and came to the attention of the public through being on a television show, but that is really where the similarities end.
Milei and Trump have very different economic views, with Milei being much more of a libertarian, while Trump is a protectionist. Milei supports unilateral free trade and told the Economist that “tariffs should not exist.” He is strongly opposed to Vladimir Putin, who he describes as an “autocrat.”
While he has the showmanship of Trump, his economic views would be more in line with Ronald Regans than any other recent American President. Milei has called former British prime minister Margaret Thatcher one of his political heroes, and says he intends to privatize “anything that can be in private hands.”
Milei’s hardline economic libertarianism is inspired by Milton Friedman and Robert Lucas, two of the best known University of Chicago economists, and Murray Rothbard who helped introduce the Austrian school of free-market economics to the United States. He has two Masters degrees and has worked for a number of financial companies including HSBC.
With a GDP of around $650 billion dollars, Argentina is one of the largest economies in Latin America. The country has vast natural resources in energy and agriculture and is home to the second largest lithium resources in the world. While Argentina produces no copper today after its last working mine closed in 2018, the country has an estimated 65 million tons of reserves, according to a 2022 government report, which is 3% of the global total. These lithium and copper resources have become increasingly important with the global electrification push.
After gaining its independence from Spain in 1816, Argentina went through alternating periods of civilian and military rule before transitioning to a civilian-led democracy in 1983.
A hundred years ago Argentina was a wealthy country and growing faster than other natural resources countries like Canada and Australia in population, total income, and per capita income. The introduction of steamships in the 1890’s allowed for the export of beef and other perishable products to Europe and North America, so at the time Argentina’s G.D.P. per capita was comparable to those of many Western European countries.
By 1913, Argentina was among the world's 10th wealthiest states per capita. The wealth generated at that time can be seen in beautiful architecture in Buenos Ares that was built during that period.
Beginning in the 1930s, the Argentine economy began its decline. A large part of this decline can be explained by political instability since a military junta took power in 1930, ending seven decades of civilian constitutional government.
Perhaps the most influential political figure in Argentina’s modern history is Juan Domingo Peron, a former military officer who was elected president three times in the post–World War II era. His populist political movement, known as Peronism, draws most of its support from labor unions and the poor and working classes.
Peronism is a loosely‐defined political ideology, based on Juan Perón's policies of social justice, economic nationalism, and anti-internationalism. It remained strong within Argentina after Perón's overthrow in 1955. The country is still dominated by this legacy. In sixteen of last twenty years Peronists have been in power in Argentina.
Historians attribute much of Peron’s long-term appeal to the charisma of his wife, Eva, who was known as Evita. She pushed for greater labor rights and the right for women to vote. Under Peron’s rule, the government intervened heavily in the economy, nationalizing the central bank and large businesses, creating vast expensive welfare schemes.
Though popular, Peron became increasingly authoritarian, jailing political opponents and restricting press freedoms. Many experts say Peronism has fascist traits, but it remains the dominant political ideology in Argentina, and its leaders have not dismantled the country’s democracy during their time in office.
Peronists are in favor of economic isolationism, shutting the country off from international trade in an attempt to protect workers from foreign competition. This focus means that over time Argentina’s exports have fallen as a percentage of global exports year after year. This makes less and less sense as the worlds economy has become more globalized.
Government spending is a massive problem in Argentina. More than a third of all workers in the country work for the government. Decades of energy and transport subsidies have weakened Argentina’s fiscal capacity. The government spent 12.5 billion dollars on subsidizing electricity last year. These subsidies were put in place to protect the poor but have bankrupted the country and have caused all sorts of economic distortions.
The main economic argument against the use of subsidies is that they cause a misalignment between prices and production costs. In doing so, they can distort markets, prevent efficient outcomes, and divert resources to less productive uses.
If electricity is being sold too cheaply, there is no profit incentive to increase generation, no money to pay to maintain the network, and the energy is not efficiently used.
Politicians put these subsidies in place to protect people against inflation, but the subsidies are so expensive that the government has to print money to pay for them fueling inflation – in a vicious cycle.
Milei is opposed to all of these ideas, [Shanty Town Clip] his plan is to implement free market policies and start trading with the rest of the world. What he is suggesting for the country is known as economic Shock Therapy. Shock therapy has been used in the past to liberalize planned economies and move them to a free-market structure through sudden and dramatic reform. Shock therapy policies generally include ending price controls, stopping government subsidies, privatizing state-owned industries, and tighter fiscal policies, such as higher tax rates and lowered government spending. The reason these reforms happen all at once rather than gradually is that they are often painful and this approach can be compared to teaching someone to swim by throwing them in the deep end of the pool.
The gradual approach has been tried in Argentina in the past. President Macri won the 2015 elections after campaigning for economic reform. Rather than implementing sudden and large cuts to government spending, Macri took a “gradual” approach to economic reform.
He removed the limit on the number of pesos an individual could exchange for dollars causing the peso to depreciate. He then reached an agreement with holdout creditors allowing Argentina to regain access to international credit markets. The government then borrowed large amounts of money to finance the existing budget deficit while gradual cuts were made to consumer subsidies. Taxes on agricultural exports were reduced in order to incentivize production and trade.
Macri was reluctant to enact brutal spending cuts as he didn’t want to lose voter support, and he didn’t want to let the currency depreciate too quickly as he was worried about inflation. The end result was that he added billions of dollars of debt and didn’t manage to make the necessary reforms.
People often blame the IMF for lending to countries with too many conditions attached to the loans, while in this case many Argentinian economists blame the lenders for not attaching enough conditions.[Clip]
Macri who failed by taking the gradual approach recently argued that there was no room anymore for mild measures. And I guess mild measures are not what are being pitched.
The situation in Argentina is a total mess. There have been more than 90 years of political instability and bad economic ideas. When I speak to Wall Street Economists and emerging markets investors, they tell me that they know very little about Argentina, because it is simply uninvestable and has been for a long time. It is simply not worth their time doing any analysis on the country.
For Milei, it’s one thing to put forth radical ideas as an economic commentator or a political candidate, but putting these ideas into effect is another thing altogether, especially in a country as divided as Argentina is. Milei has ruled out the idea of implementing his policies by Presidential decree, he will instead have to get them through the Congress, which is dominated by the parties of the center-right and center-left.
One of the big problems for Argentina is that for the size of it’s economy, it has a very small banking system and for this reason has difficulty financing fiscal deficits domestically. It then tends to borrow lots of money externally but due to its relatively small export sector – which is mostly agriculture based struggles to bring in enough foreign exchange to service the debt.
Many of its neighboring countries are also commodity dependent economies, but have a much larger export base and less debt. They have built up monetary policy credibility over time and don’t find themselves in the position Argentina is in.
So why does Milei want to abandon the Argentine Peso in favor of the US Dollar? Well, the economist Brad Setser of The Council on Foreign Relations described it on the Odd Lots Podcast last week as being like Odysseus ordering his sailors to tie him firmly to the ships mast so that he can avoid being bewitched by the song of the sirens.
I have discussed it in the past that it does not make long term sense for a country to adopt the currency of another country, as doing this means that you have no control over monetary policy, and unless the two economies are in sync and there is free movement of labor and capital between them, the smaller economy might find itself going through recessions and overheating economies that they have no means of controlling.
In the late nineties, when Argentina pegged to the US dollar, a surge in the value of the dollar (and, therefore, the peso) made Argentina’s exports uncompetitive in world markets. The economy plunged into a deep recession, and capital started to flee the country. Pegging to another currency – or using another currency can cause problems like this, but this type of problem may be the lesser of two evils – or at least that is how people feel today – when faced with hyperinflation.
The only reason a country would want to dollarize is that they have no faith in their own policymakers and need to tie their hands. Milei points Argentinian reforms that occurred in the early nineties under President Menem, when hyperinflation was brought under control by making the peso fully convertible into dollars and setting up a currency board to protect the peg. This brought the inflation rate down from more than a thousand per cent to less than twenty per cent. Milei’s criticism of this approach is that it kept pesos in circulation, meaning that the peg could eventually be reversed, which happened in 2002. Under Milei’s dollarization plan, Argentines would have to swap all of their pesos for dollars and there would be no turning back.
The argument is that Argentina must dollarize because the peso is a failed currency that even Argentine citizens reject. The political class in Argentina according to this argument can never be trusted and so should have no control over the currency. Most Argentine citizens today, already save what they can in US dollars and conduct all major transactions in the US currency.
So, what are the mechanics of dollarization? Well, it involves firstly making the US Dollar the legal currency for settling all transactions in a country, with all debts being redenominated into US Dollars. The government then buys back their own currency using US dollars – and now the country is dollarized. Doing this should solve the problem of inflation in Argentina, as the government would be no longer be able to print currency to finance deficits and would not be able to spend money that they don’t raise in taxes, so there would be no backing away from austerity measures.
Most economists in Argentina however say, that dollarization is unworkable in the short term given that Argentina has almost no dollars in its central bank and no access to international credit.
Net foreign-exchange reserves at the Argentinian Central Bank are negative, according to analysts, which means that it owes more money in foreign currencies than it has Alejandro Werner, a former senior official at the IMF, told Bloomberg a few months ago that “It’s impossible.” “Dollarizing without dollars is like saying you want the entire population to wear Nike sneakers, even though you don’t make them and you don’t have the resources to buy them.”
The official exchange rate in Argentina is fixed at just over 350 pesos to the dollar, but the black-market rate is almost three times that, creating widespread price distortions. There are more than twenty different exchange rates in Argentina right now.
Argentina is one of the few countries to tax their own exports. If an Argentinian farmer exports soybeans, they get hit first with a tax of 33% and then have to convert the dollars they receive into Argentinian pesos at the official rate which is often 1/3 the real rate they could get on the black market. This monstrous inefficiency helps to explain why the country exports so little. In order to encourage some exports, the government then gives a slightly better exchange rate to soybean exporters known as the Soydollar rate.
But there’s more…
The Qatar dollar was established during the recent World Cup when thousands of Argentines traveled to cheer for their national team in Qatar. The Malbec dollar is a rate designed to boost exports of wine. And the "Coldplay dollar" — (I’m not making this up) was created for foreign rock bands – like Coldplay -when they visit the country to torment the locals with songs like Yellow – which doesn’t mean anything. Haven’t the people of Argentina suffered enough??
As you can imagine, with all of these rates, none of which relate to the real world, Argentinians would rather not exchange dollars for the Argentine Peso and so keep as much money in dollars abroad as possible.
The Cato institute, a libertarian think tank argue that at the end of 2022, Argentinians held over $246 billion dollars in foreign bank accounts, safe deposit boxes, and mostly undeclared cash. This amounts to over 50 percent of Argentina’s GDP in current dollars. Hence, they argue, the dollar scarcity pertains only to the Argentine state.
Cato argue that dollarization could work if it was done gradually rather than all at once. They point to the examples of Ecuador and El Salvador who dollarized in 2000 and 2001 respectively. In Ecuador, the sucres in circulation were dollarized within a nine‐month period mandated by the government.
El Salvador’s banking system was dollarized immediately, but the conversion of the circulating currency was voluntary, with citizens allowed to decide if and when to exchange their local currency for dollars. In El Salvador it took over two years for 90 percent of the monetary base to be US Dollars.
The Cato institute point out that dollarization did not lead to bank runs in either case and that it led to a sharp increase in deposits, even amid economic and political turmoil in Ecuador’s case.
With regard to Milei’s plan to eliminate the central bank, in a fully dollarized economy, the central bank no longer is setting monetary policy and loses its role as the lender of last resort for the banking system. While it may still be able to provide short-term emergency funds from held reserves to banks in distress, it cannot provide enough funds to cover the withdrawals in the case of a run-on deposits. In a dollarized economy the role of the central bank is quite small, and it mostly acts as a financial regulator.
There are a number of countries around the world with no central bank, but they tend to be quite small.
Milei’s biggest struggle in enacting reform will be political. Will a man, who campaigned with a chainsaw and a sledgehammer be able to strike deals with the other elected politicians he has described as “thieves”?
Successfully implementing radical economic change in a highly polarized country that is in the depths of an economic crisis is an almost impossible task even for an experienced statesman with a congressional majority. Milei is a political newcomer, and it is difficult to predict how he will act once he is off the campaign trail and doing the hard work of running the country.
Under Argentine law, it is not the president but the congress that has the final say on the nations monetary policy and the fate of the central bank. Milei’s political party holds less than 15 per cent of seats in Argentina’s lower house and less than 10 per cent of the senate. He will have to win over a lot of people to implement the reforms he plans on.
In the final weeks of his campaign, Milei, played down some of his plans. He ruled out loosening gun controls or privatizing education, though he continues to advocate dollarization and taking a chainsaw to the state. He did tweet a few weeks ago that the closure of the central bank was a “non-negotiable matter” despite “false rumors that have been spread”, without mentioning dollarization.
Union leaders in Argentina’s aviation industry have said they will fiercely resist Milei’s plans to privatize the state airline, in an early sign of the difficult relationship he is expected to have with the country’s powerful labor movement.
Milei has selected Luis Caputo, a former Wall Street trader as his economy minister, and unlike Milei, Caputo is a known quantity.
Caputo ran the finance ministry and briefly ran the central bank under conservative President Macri. He is known for opening up the country’s access to credit, having successfully sold a 100-year sovereign bond in 2018.
There is a strong argument that instead of dollarization, a currency board is the most likely outcome under Macri. I spoke to my favorite economist on YouTube Youri from Money and Macro about why this might make sense. He is working on a video on this exact topic which will come out next week, so you should rush over to his channel to subscribe right away.
Thanks Patrick. Look, dollarization is a proven way to kill inflation, but it typically comes at the very high cost of slower economic growth and terrible economic crisis and worst of all there is almost no way of going back. Luckily though there is a less extreme solution called a currency board in which every unit of your currency is backed by a dollar equivalent, also solving inflation by severely restricting money creation. However, if you do get into trouble like Greece did in the Euro Zone at least there is still a way out. Now, proponents will say that this is exactly why Argentina should dollarize but to me dollarization only makes sense if you have completely given up on Argentina. If you have some hope left even if it's not a lot a currency board just makes much more sense.
Even without dollarization, shock therapy of some sort might make sense for Argentina, to get rid of the existing inefficiencies and distortions that have built up in the country due to decades of foolish economic policies. The first steps for Milei are probably to tighten fiscal policy and cut the fiscal deficit. It might be extremely difficult to quickly dollarize as Milei wants to do due to not having enough dollars or even the prospect of borrowing them.
It would be wise to restructure the balance sheet of the central bank, which is a total mess. Many of the assets that the central bank holds are special low-interest rate dollar bonds known as non-transferable treasury securities. These are basically low interest rate loans to the government.
They then issue promissory notes known as “Leliqs” (an abbreviation for Letters of Liquidity) to commercial banks, which carry an extremely high interest rate, incentivizing banks to hold onto the funds instead of circulating them in the economy.
They have also borrowed more foreign exchange than they hold. All of this means that the central bank doesn’t have sufficient interest income to cover its interest bill. It is hemorrhaging money.
They need to swap out the non transferrable treasury securities for something that pays an interest rate so that there is interest income coming in and restructure the Leliqs.
Argentine bonds are trading at cents on the dollar and it is clear to almost every investor that Argentina will not be able to pay them off when they mature in a few years. These should probably be restructured before they come due so that no further navy ships need to be seized in foreign ports.
A restructuring should not have any significant risk of contagion as Argentina’s $67 billion in outstanding bonds trade at around 30 cents on the dollar, so the market only values them at around $20 billion dollars. A restructuring is already priced in and should not be a shock or cause contagion to other emerging markets.
Javier Milei is without a doubt a character – he might not be the best imaginable leader for Argentina, but he is a change in a country where a change is desperately needed. A vote for any other candidate would have been a vote for more of the same, and the Argentinian people have voted for a change. Milei’s point of view is that gradualism won’t work – he is calling for revolution rather than evolution. He is a disrupter, and maybe that is what is needed – hopefully we can be optimistic for the future of Argentina.
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