Argentina has been hitting the headlines of the international media, once again, for its economic crisis. Although Mauricio Macri assumed the presidency in December 2015 promising a “normalization” of the macroeconomic situation after twelve years of “Kirchnerism,” the government is currently “reprofiling” (defaulting on) short-term treasury bills (also sending a bill to the Congress to restructure the long-term public debt) and implementing quantity-based foreign exchange controls. It was the misdiagnosis and systematic malpractice of Macri’s self-proclaimed “best team of the last 50 years” that provoked a financial chaos and a deep economic recession. During the last almost four years, the Argentinian currency devalued 80 percent and the sovereign bond market collapsed. According to official statistics (INDEC and Government of the City of Buenos Aires), the inflation rate increased from 25 to 55 percent, the real wage fell almost 20 percent, the industrial sector is utilizing only 59 percent of its productive capacity and GDP, the size of the economy, is lower than in 2015.
Because of its long-term effect, one of the most important negative effects of Macri’s failed policy has been the dramatic rise of the relevant public debt, which is debt denominated in foreign currency and held by the private sector and international organisms. This debt has gone from 73 to 172 billion dollars since December 2015. This amount includes the latest International Monetary Fund loan for an extraordinary amount of 57 billion dollars, which was extended after Macri panicked and called the IMF during the currency crisis of May 2018.
Argentina thus finds itself, once again, with the IMF as a protagonist of its domestic economic policy. Throughout its history the country has defaulted or restructured its debt eight times, and has signed 28 agreements with the IMF since the so-called “Liberating Revolution,” the military coup that overthrew President Juan Domingo Peron in 1955. To understand the foundations of this never-ending story, we need to take a closer look at what debt means and how it matters.
Theory
In the mainstream view, the neoclassical theory, money is considered “neutral” because it is assumed that, broadly speaking, the quantity of money has no long-run effect on the real side of the economy, that is, the levels of output and employment. For example, if the government tries to expand the economy by “printing” money (to cover public spending), sooner or later, inflation goes up (real wages goes down) and, consequently, the reduction in consumption pushes the economy back to the previous state.
However, John Maynard Keynes stated that “money matters” because capitalist economies are essentially “monetary production economies” where the monetary and real sides of the economy are intrinsically integrated into the process of capital accumulation (By the way, a similar idea was already present in Marx’s “general formula of capital” where firms invest money in order to produce commodities, sell them in the market, and make more money.). Following our previous example, if the government increases the “effective demand”, we don’t have to expect an inflationary pressure but an economic expansion because firms will sell more, and consequently they will be willing to invest more and hire more workers in order to increase the productive capacity.
Unlike mainstream neoclassical economists, Keynesian economists consider the money contracts have real effects in terms of both output and employment. For this reason, because money matters, the type of currency denomination of money contracts matters too. Take debt, which is a financial commitment denominated in a specific currency that has to be settled in those monetary terms, not others. This nominal aspect is extremely important because countries usually default when they have commitments in a currency that they don’t control, as their central banks fall short in foreign reserves and they can’t roll-over the debt because of international credit rationing. If public debt were denominated in local currency the central bank could always act as lender of last resort. This is why, for example, the public debts of the United States and Japan represent approximately 100 and 240 percent of the GDP respectively, but nobody seriously expects a default in those countries.
However, Argentina defaulted in 2001 with a public debt that represented “only” 50 percent of the GDP and, currently, the country risk premium (the yield spread between long-term dollar denominated debt of Argentina and United States) has skyrocketed despite a relevant public debt of 40 percent of the GDP. How is this possible? The problem is not a supposed “debt intolerance” of Argentina as economists Carmen Reinhart and Kenneth Rogoff point out. The key difference is more technical and less psychological: the US treasury issues bonds in dollars, and Argentina does too!
From a historical perspective, we could say that central banks were created to finance fiscal deficits, especially during war time. Even considering that today central banks rarely lend money directly to the government (treasury), they do still operate indirectly. The mechanism is more or less the following: when a government borrows too much money from the market, bond prices tend to fall because of the excess supply of bonds or, what is the same, the interest rate or “discount rate” (the ratio between the face value and the market price of bonds) tend to rise. However, with the exception of extreme cases of institutional constraint, such as currency board systems or monetary targeting, central banks normally conduct the monetary policy by controlling the interest rate through standing facilities or open market operations. Thus, when the central bank intervenes in the money market in order to keep the market rate close to its target rate it creates new reserve balances. In other words, the possibility of a default is zero when public debt is denominated in local currency because, directly or indirectly, the central bank creates the liquidity that the treasury needs to settle its financial commitments.
Practice
Because Argentina was never as rich in natural resources as many people think, from the global crisis of the 1930s until the rise of neoliberalism, there was some political consensus about the need to implement an import-substitution industrialization policy. However, economic development is not an easy task. Excepting the East-Asian success stories, developing countries remain more or less “developing.” Their challenge is always to prevent economic growth being stopped by the “external constraint” of dollar shortage or balance of payment crisis. As long as the industrial sector is still “developing,” it runs a chronic sectorial trade deficit because manufactured exports are not enough to cover the huge needs of imported inputs and machinery.
In the case of Argentina, economically speaking, the agricultural sector helps a lot because through its exports the country gets dollars to pay for industrial imports. However, the structural problem is that exports revenues are not enough to solve the dollar shortage of the whole country and, consequently, governments tend to borrow dollars abroad. Doing this increases the economy’s external financial fragility; sooner or later a currency and debt crisis ensue.
During these times of crisis, the IMF enters the scene. This organism was created in the context of the Bretton Woods agreement after the Second World War. Originally, it was designed to provide exchange rate stability and to avoid balance of payment crises among its members. Remember that, broadly speaking, the core of the Bretton Woods system was the so-called “gold standard” (which in practice was a dollar standard) where countries pegged the value of their currencies to the US dollar and the US Federal Reserve pegged that to the price of gold, fixed at $35 an ounce. The Fed abandoned the (gold standard) system in 1971 and the international monetary system became fully based on the US dollar. Since then, and in the context of Friedman’s “Monetarist counter revolution”, the IMF has promoted flexible exchange regimes under the belief that free markets are efficient.
IMF loans come with well-known strings attached: programs of fiscal austerity (which imply government spending cuts), currency devaluation (that generates reduction of real wages) and monetary tightening (which increases the cost of borrowing for firms). At the beginning, IMF loans alleviate the dollar shortage. But sooner or later the situation gets worse because the dollar-denominated debt has been increased and the economy agonizes over the recession generated by those contractionary policies.
(Mal) practice
The first mistake of Macri’s administration is derived from its inflation theory. From the beginning, the government operated under the belief that inflation was a “monetary phenomenon” generated by “Kirchnerism” that had been monetizing the fiscal deficit directly. For this reason, Macri started to replace the peso-denominated debt held by the central bank with dollar-denominated debt held by local and international investors. Since the government expected a “rain of investments” from abroad for the sole reason that now there was a market-friendly president, they thought it would be easy to afford the service debt in dollars.
However, Argentinian price instability is a clear case of “cost-push inflation” where currency devaluations are determinant: when the currency falls, inflation goes up due to the increase in prices of imported industrial inputs and tradable agricultural commodities consumed internally. By replacing the peso-denominated debt with dollar-denominated debt, Macri not only put the sustainability of the public debt at risk, but also created the conditions to accelerate the inflation rate.
I would say that for the first time in Argentinian history, the issuance of sovereign bonds in dollars (and not in pesos) was a domestic political choice not imposed by international financial conditions, as has happened in the past. Until recently the only way for developing countries to borrow dollars from financial markets was through dollar-denominated contracts such as international bank loans (as happened in the 80s) or treasury bonds (as during the 90s). Since the 2000s, thanks to the “commodity boom” and the international liquidity derived from the Fed’s “unconventional monetary policy,” developing countries started to develop huge bond markets in local currency that attracted a lot of capital flows, which explains why most developing countries have dramatically reduced their dollar-denominated debt in the last years. However, Argentina has been an “exception” to this global pattern.
The malpractice of the Argentinian government was not only increasing the dollar-denominated debt. The second mistake was the monetary policy and the Central Bank’s interventions during exchange market pressures. The function of central banks is to stabilize unstable markets and keep calm when panic strikes. Yet in Argentina the erratic operating procedures of the Central Bank became an additional destabilizing factor. For example, during the currency crisis of 2018, the Central Bank burnt large amounts of foreign reserves (to defend the value of the currency) and then allowed a huge depreciation from one day to another, or caused extreme ups and downs of the interest rate on the same day.
Finally, the call to the IMF was another mistake. Although Argentina started to suffer some international credit rationing at the beginning of 2018, there was still some margin to manage the sustainability of the debt through market mechanisms. Until the appearance of the IMF, most financial investors were not so clear to what extent the Argentinian situation was serious. After the government asked the IMF for a loan, everyone understood Argentina was in trouble again and, automatically, the country was left out of the international lending market.
Yet the problem with the IMF is not only the “stigma effect” that it generates. IMF loans are subject to the application of those orthodox economic policies described above. For example, fiscal austerity does not solve the roots of economic crisis because the problem is the structural dollar shortage of the whole country and not a transitory peso shortage of the government, which ultimately could be financed by the central bank as discussed above. The only way that a contractionary fiscal policy could “improve” the balance of payments is by shrinking the size of the economy (recessions reduce the demand for imports), that is, excluding people from the system.
Argentina is again facing a new debt trap. The return to the IMF doesn’t seem to be temporary, since the Central Bank doesn’t have enough foreign reserves to settle the country’s external financial obligations. However, orthodox contractionary policies usually are not effective to solve debt crises: the Argentinian collapse in 2001 and the economic stagnation in European countries like Greece are good examples of that. For this reason, the IMF should assume part of the responsibility for the failure of its standard policy and negotiate a sustainable macroeconomic program. The starting point for a macroeconomic stabilization is the recovery of all of the Central Bank’s policy tools, for example, a full freedom to intervene in money and exchange markets, something that is not allowed by the current IMF agreement. Although it may sound an exaggeration, to govern Argentina is to govern the exchange rate.
Juan Matías De Lucchi is a PhD Student in Economics at The New School for Social Research. He specializes in macroeconomics, monetary economics and exchange markets with a focus in developing countries. He holds a Master’s degree in Economics from the Federal University of Rio de Janeiro and a Bachelor’s degree in Political Science from the University of Buenos Aires. In Argentina he taught monetary economics at IDAES-University of San Martin and University of Moreno, and was Board Advisor of the Central Bank (BCRA). Currently, he teaches macroeconomics at John Jay College CUNY.
