Last week it was reported that Cristina Fernández de Kirchner would convert her savings from dollars to pesos, and urged her ministers to do likewise in order to provide an example and to give a concrete demonstration of faith in the Argentinian currency — and, by extension, the economy of Argentina (cf. Argentina’s President Fernandez stops saving in dollars). Then the Financial Times published Dollar curbs squeeze Argentine economy by Jude Webber in Buenos Aires. What’s going on with Argentina and dollars?

What’s going on is an illustration of Gresham’s law, commonly stated as “bad money drives out good money” (and also known as the “Copernicus-Gresham Law” because it was earlier formulated by Copernicus). While one often thinks of “bad” money as debased coinage, in cases of de facto currency pluralism, when more than one form of legal tender is employed in economic transactions, the distinct forms of currency might individually gain a reputation as “good” or “bad.” Argentine pesos are losing their value at an official inflation rate of almost 10 percent, but at an unofficial rate that may be several times higher. As a result, Argentina has been experiencing substantial capital flight as people look for safe places to put their money. In response to capital flight, the government has attempted to crack down with regulations on buying dollars.

The limitations placed on dollars is having an effect in the wider economy because, as the FT article cited above explains, real estate prices in Argentina are denominated in dollars. In other words, with big ticket items you have to come up with dollars because people don’t trust pesos when a lot of money is on the line. The FT article said, “Consequently the property market is paralysed, with a knock-on effect on construction.”

Another way to express the denomination of real estate transactions in dollars would be to say that the real estate market in Argentina has been dollarized — a de facto dollarization, to be sure, but still a dollarization. And with a substantial portion of the economy dollarized, but with the greater part of the economy still denominated in pesos, Argentina has de facto currency pluralism.

At present the situation is a mildly tense standoff between a people and its government; the people are trying to secure as much of their savings as they can, while the government is trying to clamp down on strategies of securing savings that exports them from the country or transforms them into dollars. Maybe it would be better to call this a cat-and-mouse game than a standoff. But the worry here is that a tipping point will be reached and instead of a slow-motion sequestering of good money, there will be a sudden loss of confidence that generates a run on the banks. People in Argentina know what it is like to go to the bank and not be able to withdraw their money, so they are with drawing it now and either sending it abroad or buying something with it that is relatively immune to inflation, financial panic, and economic collapse.

As I have said in many posts in the past, this kind of situation is potentially devastating to the middle class. The poor have no savings and live from day to day; the rich already have most of their money invested elsewhere in the world in financial instruments not directly connected to their country of origin. It is the middle class that has a little bit of money in the bank — saved for a home, saved to start a business, saved for an education, or what have you — that suddenly becomes unavailable in the financial panic, and in the aftermath of the panic may be devalued to some tiny portion of its former value. Again, it is the middle class who do not have the connections or the knowledge or the financial savvy and expertise to shelter their modest savings that are most at risk. And they know it.

Argentina’s economy is large, and therefore diverse and robust, but the level of mismanagement that is the case at present leaves one wondering how long the game of musical chairs can go one before the music stops. The recent re-nationalization of YPF is only a symbol of a much more pervasive government intervention in markets that is not serving the people of Argentina (though the move to re-nationalize YPF was widely popular — I have my Twitter account set to tell me what is “trending” in Argentina, and in the wake of the re-nationalization there were several trending topics related to YPF, all of them favorable to the re-nationalization). The economy is now hemmed in by restrictions and regulations that are choking off trade.

Argentina is turning its back on globalization both by regulations that are hampering international trade and by essentially opting out of global financial markets by failing to address the long term structural issues that led to its default. The FT article cited above quoted Martín Redrado (former governor of the Argentine central bank who was tossed out by Cristina Fernández) as follows:

“Argentina is not part of the international financial community so cannot access international credit markets and does not have [large] portfolio flows or investment flows. The trade surplus, which is decreasing, is the only source of dollars.”

It sounds a bit strange to say it, but what we have here is Juche South American style — an attempt to be economically self-sufficient which sounds good rhetorically but runs counter to everything we know about economics. Trade benefits everyone involved. That’s why people trade. If they did not see it in their interest to trade, they would not trade. The Argentine government is painting itself into a corner where its only remaining economic strategy is to keep ratcheting up the same regulations that are choking the life out of the economy.

Of course, there is always the possibility of reversing that strategy and deconstructing the artificial barriers to trade that choke economic growth, but when a government is politically and ideologically tied to a particular strategic economic policy, reversing that policy can create a lack of political confidence that is parallel to the lack of economic confidence that causes bank runs.

The de facto dollarization of some sectors of the Argentine economy puts definite limits on the extent to which the government can ratchet up further restrictions on the use of dollars, but as long as dollars are in use, the “good” dollars will be hoarded while the “bad” pesos will be used in exchange, in line with Gresham’s law. At the same time, a flourishing black market in dollars required for certain transactions (like real estate), with dollars trading at a premium well above the official exchange rate, fosters a sense of cynicism and a contempt for rule of law. When institutions force individuals into crime and dishonesty simply in order to go about the daily business of life (like buying a house), it is difficult to have any really genuine faith in these institutions.

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Grand Strategy Annex

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Argentine President Cristina Fernández de Kirchner had a large color photograph on the cover of today’s Financial Times — not, like the last time, when she had just won a landslide reelection victory, but because she is initiating a process of nationalizing (or, rather, re-nationalizing) the largest oil company in Argentina, YPF. The Financial Times reported this as follows:

A visibly angry Ms Fernández made the announcement on live television to a cheering audience at the government palace. Rejecting recent criticism from Spain, Ms Fernández said she would not bow to foreign pressure. “I am a head of state and not a hoodlum,”’ she told business, union and political leaders in the audience.

The visible anger may have been due, according to another story in the FT (Fernández takes her revenge), to the Malvinas/Falkland Islands dispute not having been taken up by the Sixth Summit of the Americas which just concluded in Cartegena. President Fernández left the summit early, and, reportedly, disappointed. While it seems like stretch to me to attribute the re-nationalization of YPF to a desire for revenge over the Malvinas (since it is Spain that is being punished by this, rather than the UK), this FT piece is nevertheless well worth reading for its account of the economic and political vicissitudes experienced by YPF, which apparently had better arrangements with the president’s deceased spouse than with her.

Not surprisingly, the re-nationalization move has great popular appeal in Argentina, as evidenced by the cheering audience mentioned above. Since the global financial crisis, and indeed since before the crisis, it has become fashionable (especially in Latin America) to fix the blame for all problems on “neo-liberalism,” and it is understood that one of the key features of neo-liberalism is privatization. Thus re-nationalization is seen not only as an intrinsically good thing for the people of Argentina to have control over their resources (what President Cristina Fernández de Kirchner has called, “recovery of sovereignty and control”), but also as a blow for “economic justice” that will reverse the perceived errors and injustices of privatization and neo-liberalism.

Even while the president was being reelected by a landslide there were many articles in the media about the financial difficulties that the president was inheriting from her previous term, and not a little speculation on how exactly she would go about handling it. Well, now we know. After squeezing the country’s once-legendary agricultural industry and nationalizing pension funds in order to get state hands on more resources, the president will now turn to further nationalizations, and with oil prices rising YPF is a very tempting target. Because Argentina has been frozen out of international credit markets since its debt default ten years ago, the Argentinian economy has been forced to operate on a cash basis vis-à-vis the rest of the world. This absence of the irresponsible use of credit has resulted in the economy growing for the past decade, which has in turn resulted in some superficial economists learning the wrong lesson from Argentina’s default (cf. Incommensurable Defaults).

Nationalizing YPF has strong parallels with the policies pursued by Cristina Fernández de Kirchner and, before her, by her husband (since deceased) Néstor Kirchner in regard to agriculture. The FT’s front page article claimed:

Ms Fernández accused Repsol of “emptying” YPF. But analysts and industry executives said the real culprit for Argentina’s loss of energy self-sufficiency and ballooning imports bill was the government’s failed energy policy, which set domestic prices at well below international levels.

Simon Romero and Raphael Minder wrote in Argentina to Seize Control of Oil Company in the New York Times:

Seizing YPF appears to be a popular move in Argentina, where caps on residential energy prices and a growing economy have helped push energy demand to new highs. Argentina’s oil production has declined in the last decade as regulatory uncertainty persisted over price caps and the policies over profit remittances. Many Argentines still resent the privatization of state-owned companies in the 1990s, so taking on YPF gives Mrs. Kirchner the opportunity to go after a symbol of that time.

With Argentina’s formerly profitable agricultural industry, the Kirchner’s kept prices below market rates internally and created high export tariffs. Not surprisingly, agriculture become unprofitable in Argentina, and many Argentinian producers moved their operations to neighboring Uruguay. Now little Uruguay exports more beef than spacious Argentina. Like most populist economic measures, the short-term feel-good benefits come at a very high long-term cost.

President Cristina Fernández de Kirchner has continued populist policies with the oil industry, and with petrochemicals priced below market rates they are being used unsustainably. Now that Spain’s Repsol management has been ousted, and even banned from the YPF building, not merely the prices but the actual operations of YPF will be politicized. The model for this is the politicization of the administration of PDVSA after the failed coup against Hugo Chavez, which latter oil company has declined in efficiency continuously since the ouster of its experienced management.

Given how disastrous this move will likely be for Argentina and its economy in the longer term, and the negative diplomatic fallout that will result, one must ask why the president is doing this. The short answer is Peronist populism, which has been entrenched in the Argentine political system since the middle of the twentieth century. The longer answer would include many factors, including the fact that, while popularly elected (and by a wide margin), Cristina Fernández de Kirchner can appeal to David and Goliath themes. One need not be an unelected tyrant in order to make a show of one’s defiance and claim to represent the underdog.

Argentina’s century-long decline will not be arrested by populism or re-nationalizations. People may cheer in the short term, but the Argentine economy will stagnate in comparison to other economies in the region — especially in comparison to Brazil, Chile, and Peru, which are experiencing robust growth on sustainable foundations. And in this context I do not necessarily mean “stagnation” as a complete absence of growth, as it is more likely that Argentina will experience unsustainable growth followed by repeated crashes when reality catches up with the market. This has the effect not only of immiserating the people, but also of creating an unstable and unpredictable business climate.

Argentina’s decline will not be dramatically visible over a year or two, just as steady but small economic growth is not obvious over a year or two, but over a decade or two these things add up. And in addition to not being immediately evident, one must compare the reality with the counter-factual conditional of what the Argentinian economy might have been if more sustainable economic management had been practiced. Since human beings have short and imperfect memories, and cannot usually grasp what is counter-intuitive, there is very little penalty paid by a political regime for its foolishness, especially when a given regime is out of office by the time the consequences of its actions must be paid for. While all systems of popular sovereignty suffer from this weakness, the effect is exacerbated by irresponsibility.

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Grand Strategy Annex

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Just a few days ago in Axioms and Postulates of Strategy I wrote the following:

“Emphatically, facts do not speak for themselves. Perhaps it would be better for formulate it like this: facts cannot be counted upon to consistently and univocally speak for themselves. In some contexts and situations, facts sometimes speak for themselves, but this is a function of the conditions under which the facts are manifested. All other things being equal — i.e., when the conditions under which a fact is manifested cannot be controlled or limited — facts do no speak for themselves. This is what Nietzsche meant when he wrote that there are no facts, only interpretations. The modern quest to attain insight through accumulation of and immersion in a mass of detail is more likely to overwhelm than to enlighten.”

It follows from the fact that facts do not speak for themselves, and many (or at least several) different constructions can be erected on the same set of facts. This is the source of incommensurability. Two incommensurable bodies of knowledge — two incommensurable sciences, or even two incommensurable economies — can be raised on a single set of facts.

In the complex world of the social sciences, which involve not only the ambiguities of the world and its facts, but also the ambivalence of human agents whose motivations and purposes are present throughout every claim and counter-claim, the possibilities of incommensurability are raised to a higher order of magnitude. And so it is with economics, which is perhaps the most mathematized of the social sciences, or I could say that it is the most social of the “hard” sciences. Incommensurable economic doctrines flourish, and so the intellectual world is awash with economic claims and counter-claims, both of which seem to be supported by “hard data” (as the contemporary idiom has it), but which also seem to be mutually inconsistent, if not to describe entirely different worlds.

This incommunsurability, the ability to raise plausible but mutually incompatible constructions upon what would appear to be a single state of affairs, was on display in a page-long article by Jude Webber on Argentina’s debt default in the Financial Times for Tuesday 19 July 2011. The article was billed on the front page as “Wise or Lucky: Argentina’s model default,” while on the inside page it was called “Argentina: A high-risk recovery.”

The subject of default is uppermost in the minds of those in the financial community because of the looming default of Greece, a member of the Eurozone, and the shaky condition of Ireland and Portugal. The financial contagion is spreading through the Eurozone and now is affecting Italy and Spain also, whose borrowing costs have risen dramatically just in the past few days. Comparing Argentina in 2001 to Greece in 2011 is of course a lot like comparing apples and oranges. Nevertheless, comparisons are made, and this FT article made a number of comparisons of this order, both implicit and explicit.

I was surprised at the extent to which the author went easy on the Argentine default, and although the article hedged on any kind of outright declaration that Argentina was a “model” for other insolvent nation-state, given its current economic growth some ten years on after the default, this was clearly the picture that emerged. Part of this is to be put to the fact that a Greek default is now considered inevitable, and no one expects the debt to be paid off in full (investors are said to received a “haircut”), the Europeans are looking to a silver lining to the clouds, trying to convince themselves that default is not disaster and that there is a future after default within the Eurozone.

There was, in the article, no explicit recognition of the fact that, since Argentina’s default, that country has been cut off from international credit markets, and as a result of this has had to budget within its means for the past ten years. At least part of the present performance of Argentina’s economy is due to this forced budgetary discipline. This is not, of course, the only reason for Argentina’s superficially good economic statistics. The article chooses to focus on the ways in which international market conditions have, for the past ten years, converged to Argentina’s benefit, which the explicit proviso made that conditions could change at any time and, which them, the relative fortunes of the country. I do not disagree with this, but it is far short of an adequate picture.

I wrote above of Argentina’s “superficially good” economic statistics, and it is important to look beyond the surface in order to get the fuller picture. It is also important to consider the history of Argentina’s economy. History is always relevant to the interpretation of the present, but in the case of Argentina it is more than relevant, it is poignant, because Argentina was once a wealthy country. While Argentina has recently been admitted to the G20, and seems on the path to recovery, and perhaps even eventual wealth, it seems questionable whether the combination of sovereign debt default and a political balancing act within the Argentinian economy can produce lasting results, or whether the country will slip into a prolonged economic twilight of the sort that most pundits now predict for Greece.

Argentina is a large country, geographically extensive with a temperate climate that favors agricultural production. During the nineteenth century Argentina was among the wealthiest countries in the world due to its agricultural exports. That is to say, Argentina relatively early in its history moved to industrial-scale agricultural and an export-based economy. We all know, from recent financial reportage from east Asia, and especially from China, of the vulnerabilities of an export-driven economy, and the need to build an internal market in order to increase resiliency and decrease vulnerability.

Agriculture has continued to be a mainstay of the Argentine economy throughout the twentieth century up to the present, and it is still synonymous with the production of beef. But the agricultural economy is not the whole story. Set in the midst of Argentina’s vast spaces are many surprisingly large cities. I have previously wrote about how Sarmiento urged the urbanization of Argentina because he considered cities to be a civilizing force. This is one of Sarmiento’s intellectual legacies, and comes across clearly in his Facundo.

In a recent BBC piece, Rise of the Asian megacity, the focus of the article is Asian cities, but I was interested to note that for the statistics in 1990, when only ten megacities were named, while half were in Asia, the other interesting fact, not expressed in the BBC story, was that the other half of the ten cities were all in the western hemisphere, and Buenos Aires was one of these ten largest cities in the world. According to current statistics, Buenos Aires is now larger than Los Angeles, and the only larger cities in the western hemisphere are Sao Paulo, Mexico City, and New York.

When I visited Argentina last year I didn’t travel to Buenos Aires, but I did fly in and out of Cordoba, which is Argentina’s second city, with just over a million in population. I was quite surprised by the size of the cities in the Argentina. On every map a city just looks like a small dot, and the unfamiliar traveler often doesn’t know what to expect. Thus when I arrived in Santiago del Estero, San Miguel de Tucuman, and San Salvador de Jujuy, I was taken aback by the shear size of these cities of which I had no previous knowledge. All were big, bustling urban centers.

To get to these cities, however, one had to pass through mile after mile of open country, and as one passes through the small towns along the highway one sees the legacy of Argentina’s agriculturally-based economy: almost every small town had a John Deere dealership, and the greater part of the heavy truck traffic on the highway consisted of agricultural shipping.

Like many places in the world, Argentina has a divided soul: it is both rural and urban, and both rural and urban traditions have contributed substantially to its cultural heritage. I suggest that Argentina is as profoundly affected by The Rural-Urban Divide as is the US, if not more so. Apart from Sarmiento, the literature of the southern cone is rich in stories of inter-generational alienation between the gaucho tradition and the emergent urbanism the transformed the gaucho from a vital part of the landscape to a romantic literary motif. (This is especially the theme of Uruguayan playwright Florencio Sánchez.)

Argentina’s divided soul (no less than that of the US) has led to divided policies, but whereas the divided souls and policies of the US has resulted in less that optimal economic polices, the increasing marginalization of agricultural as an economic force has limited the impact of these policies. In Argentina, where agriculture is still a major force in the economy, policies that have sought to placate urban populations through the politics of subsidy have been devastating for agriculture, and therefore devastating to the economy on the whole.

The Kirchner-Fernández administration has been actively interventionist in the economy, and has been interventionist in the Peronist populist tradition. But this has been an urban populism that treated the agricultural sector as a producer of wealth that can be expropriated and redistributed. The result has been a series of policy interventions that have penalized the traditional agricultural export model, and has even forced agricultural producers to sell at a loss to the domestic market.

Not surprisingly, some major Argentinian agri-businesses have been moving assets to neighboring Uruguay, and indeed the Financial Times article mentions in passing the problem of capital flight. There can be perhaps no more dramatic illustration of this than the fact that Uruguay has now bypassed Argentina as an exporter of beef. I urge the reader to look at a map and compare the relative geographic sizes of Argentina and Uruguay. Even the reader who is unfamiliar with Argentina’s tradition of producing beef for export will immediately see that something is a little strange when diminutive Uruguay can export more beef than Argentina. (Take a look at Uruguay forecasts beef exports will total 1.4 billion USD in 2011.)

In other sectors of agriculture, Uruguay’s exports of fruit have increased sharply. For example, blueberry exports have doubled (mostly going to the European Union), while overall fruit exports have exceeded US$100 million for the first time in its history. Uruguay’s fruit exports are still dwarfed by those of Argentina, but we see a broadly based increase in Uruguay’s agricultural production and export. Thus while Argentina’s economy has been growing at 6 percent per year since the initial contraction following the default, its agricultural industry has been lagging while neighbors pick up the slack. The traditional engine of industrial development and national wealth in Argentina has been marginalized by political intervention, and this puts the sustainability of Argentina’s present financial model in question.

While it is easy to say that policies can be changed and the agricultural industry can resume its role, there will be an inevitable loss of market share and perhaps lost decades of national wealth. Unlike, for example, the mineral wealth of the DPRK or the petroleum reserves of the US held in ANWR, which are essentially resources banked in the ground, and which can be extracted more efficiently and more profitably in the future with improved industrial technologies, the loss from missed agricultural opportunities is a loss that cannot be made up at a later date. If you don’t sell fruit or beef this year, someone else will sell it, and the purchaser will likely consume it this year. You may sell to them next year, but you missed your chance to profit from this year.

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Grand Strategy Annex

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