Economic divination for Argentina

I promised I'd make a guess about Argentina's economy in the near future. So here it is...

The Argentine government is making considerable effort to maintain the peso-dollar exchange rate high. It does this by restricting short-term incoming flows of dollars (typically speculative investments), by appropriating part of the dollars brought in by exports using retenciones (export taxes), and by increasing demand for the dollar in the local currency markets. The latter is the most significant part of the strategy, and it involves the Central Bank and the Treasury.

The Central Bank buys dollars in the free market using pesos it emits (yes, there's a little machine that spits out Argentine peso bills). In order to prevent all these pesos from reaching the public, increasing liquidity and "heating" the economy (which involves inflation), the Central Bank subsequently sterilizes these emissions by emitting debt letters. These are like bonds or stocks; they represent an obligation for the Central Bank to regularly pay interest to the holder. The public, seduced by the advantageous rates offered by the Central Bank, buys those letters, and the Central Bank gets back the pesos it just emitted.

The Treasury cannot emit pesos, so it uses its own funds, gathered through taxes. The Treasury cannot buy dollars if it doesn't have pesos to spend, so keeping a sizable fiscal surplus is a must.

Now the guessing begins. First, suppose the fiscal surplus decreases. This would leave the Central Bank in charge of buying dollars without help from the Treasury. This is indeed happening now. What about the Central Bank? The present strategy looks nice, but the bank is actually indebting itself to buy dollars. As it tries to get investors to buy more and more of its debt, it needs to offer them higher and higher interest rates. This influences all rates — including the rate that banks charge you when you go asking for a loan. In short, this makes (borrowed) money more expensive, and discourages private investment (you need credit to start a new business or to get those shiny, new, efficient machines to upgrade your industry).

Now, lack of investment is cited as one of the causes of inflation. If industries don't invest, they don't produce enough; offer lags behind demand, and prices rise. Industries recovered fast after the collapse because they'd been using only a fraction of their productive capacity since the 1990s. They simply got the engines started; but now they need more and bigger engines, and it may be too expensive to get them, especially when you have to get them from abroad (remember a key part of the economic policy of this administration is keeping imports expensive!).

At some point, the Central Bank will have to stop emitting pesos and buying dollars. What will happen then? As millions of dollars enter the country (through exports, tourism and investment), the exchange rate will fall. This will make it easier for everybody to import goods, and may bring down the prices of many products which have an imported component, but it will also make our exports less competitive, and will expose our local industries to competition from foreign producers. The export taxes, which comprise a large portion of the fiscal surplus, will yield less and less, so the state will have less money to spend.

As the dollar locally decreases in value, business will have to make some choices. Those who sell only to the local market will face competition from abroad. If the government doesn't block imports using tariffs, you'll lose, unless you become more productive. You can get your employees to work more hours for equal or less pay, or you can fire employees and use more efficient machines. If you're like many, many Argentine businessmen, you'll do this for a while, then sell everything overnight for a bunch of cheap dollars, file a fake bankruptcy, pack your gear and head for Miami.

Those who depend on exporting their production or who won't flee the country will try to ask for subsidies from the government "to preserve the national industry", but remember, the government doesn't have money to spend on you. It will, maybe, if you have contacts in the high spheres — there's always money to cut from welfare, education and public health, in order to help the local industry barons.

Unless something really amazing happens, the surplus of the trade balance will decrease and the fiscal surplus will follow, as the export taxes gather less and less. This will cool down the economy, since the state will be forced to cut spending and the big exporter conglomerates will see their profits reduced. This should bring down prices of certain products that currently have inflated local prices (but don't bet on it!).

The crux of the matter is what the state will do to finance itself. It's already apparent that the national government is interested in fueling consumption, but doesn't intend to do it through a progressive tax scheme. The IVA (i.e. VAT) is 21% for most types of goods, ridiculously high and regressive. A truly progressive government would increase the taxes that apply only to the rich, and decrease the IVA, which applies to everything from bread, beef and lettuce to plasma TVs and luxury cars. Tax evasion is rampant in Argentina, but it should be easier to cash in a tax that applies to only a tiny fraction of the population — the couple of thousands of individuals and companies that make tens of millions each month. As it is now, IVA is automatically added to all goods and services sold legally, which means everything you buy in the supermarket is one-fifth more expensive than it should, and many goods and services are exchanged outside the legal channels, thus depriving the state of funds.

The state is highly indebted in both pesos and dollars. If I were in charge, I'd start paying right now. There's no need to have more reserves. One of the reasons why it's difficult for the Central Bank to keep the exchange rate high is because it has $37 thousand million in stock and everybody knows, so nobody buys dollars (except importers and tourists). The Central Bank and the government should coordinate efforts to pay off dollar-denominated debt. With reserves going down, the dollar will become attractive and demand will increase, thus pushing the exchange rate up without the need for state intervention. It's a bit stupid, IMHO, to have a massive external debt and yet keep it unpaid while you hoard surplus money with no end in sight.

So this is how I see it, in short: a cheaper dollar, a good deal of inflation due to lack of offer, a state with funding problems, spending cuts, lower investment, less liquidity. Stagflation? I might be off the mark by a large degree (you never know in today's world, or ever, in Argentina). Only time will tell...