Over the past century, Argentina has experienced a seemingly never-ending succession of economic booms and busts. The upswings are accompanied by generalized euphoria – assurances that this time is different, along with lofty promises that the country will finally join the group of advanced nations.

During the downturns, all seems lost: think runaway inflation, devaluation, capital flight, scorching poverty. And in case you didn’t get the picture the last time, there’s always another. Since World War II, Argentina has been forced to restructure its debts denominated in foreign currency in 1956, 1982, 1989, 1993, 2001, 2005, 2014, 2018 and 2020.

When I think of Argentina’s history, clichés come to mind. My favorite: Argentina is the country of the future and will always be! But cynicism is not an explanation. How did a nation that in the early 20th century was among the wealthiest in the world end up with half its population living in poverty today? Why has economic growth per capita been zero during the past 15 years? Why is Argentina so prone to hyperinflation? Will it ever become a “normal” (and, maybe, boring) country?

These questions resurfaced with a vengeance after the election of uber-libertarian economist Javier Milei as president in November 2023. On the campaign trail, Milei vowed extreme measures to deal with extreme problems – to close several government ministries, to eliminate most economic regulation, to abolish the central bank and to adopt the U.S. dollar as the national currency. An immediate goal was to reduce inflation to a low, low 2-3 percent per year. The “per year” in the last sentence is important, because the monthly inflation rate topped 25 percent in December 2023. (That translates to an annualized rate of almost 1,500 percent.)

As the figure below shows, Milei’s stabilization program has managed to bring inflation down to the 4-5 percent monthly range. That’s a start, but the remaining task is daunting. The current monthly rate is still more than 10 times higher than what the president aspires to.

So questions naturally follow. Is Argentina following an anti-inflation strategy that is sustainable? Why has Milei reneged on his promise to close the central bank and to put monetary policy on autopilot by adopting the dollar as the country’s currency?

The Adjustment Program and Milton Friedman

President Milei defines himself as an “Austrian economist,” a follower of Nobel Prize winner Friedrich von Hayek. The Austrians see themselves as true conservatives, but seek distance from orthodox monetarists like Milton Friedman. Yet Argentina’s current anti-inflation plan appears to have been adopted whole cloth from Friedman’s playbook.

At the core of the program is a massive “fiscal shock,” one not very different from the policy Friedman recommended to Chilean dictator General Augusto Pinochet in 1975. During his inaugural speech, Milei told the people of Argentina in his usual didactic style that since “there is no money,” the anti-inflation program could not be gradual. He did not mention Friedman or Pinochet, but everyone in the know made the connection to Chile in the mid-1970s.

Since January 2024, the fiscal adjustment has been brutal. Thousands of public-sector employees have been dismissed, subsidies have been cut or eliminated and investment projects have been shelved. But the most important component of the fiscal shock has been the reduction of the inflation-adjusted salaries of government workers and the collapse of pensions for seniors in terms of purchasing power. What government statisticians call the Economic Activity Index declined in December 2023 (-4.2 percent), January 2024 (-3.9 percent), February (-2.7 percent), March (-8.3 percent) and April (-1.7 percent). The index did finally see a modest uptick in May, the last month with available data at the time of this writing. Meanwhile, the official rate of unemployment increased from 5.7 percent in the last quarter of 2023 to 7.7 percent in the first quarter of 2024, accompanied by (no surprise) a significant increase in the number of people living in poverty.

On the positive side, the budget deficit has been eliminated so the central bank does not have to print money to finance government spending. Eight months ago, no one thought that this could be done so swiftly. But will
it last? Much depends on whether Milei will be able to muster sufficient political support to stay the course, even as living standards tumble.

The fiscal shock is not the only element in the package taken from the monetarists’ bag of policy tools. Friedman famously said that “inflation is always and everywhere a monetary phenomenon.” A straightforward implication of this principle is that tight monetary policy should be a key component of any initiative to stop inflation.

In “normal” countries, the central bank manages monetary policy through changes in the very short-term interest rate, which in the U.S. is called the federal funds rate. Textbooks tell us that interest rate hikes result in reduced business and household liquidity and less demand for credit, with lower inflation to follow. However, at the risk of repeating myself, Argentina is not a normal country.

In contrast with most nations, higher interest rates in Argentina actually lead to faster money creation and, thus, to more – not less – inflation. The explanation: The central bank has issued an enormous amount of short-term debt at very high rates – during the third week of July 2024 (when this was written), the annualized rate to borrow overnight was 49 percent! So, to turn over its liabilities without defaulting, the bank is forced to print even more money, fueling the inflation it seeks to reduce.

To tackle this issue, the Argentine authorities recently announced that they were transferring the central bank debt to the Treasury, and that the central bank would not turn to the proverbial printing presses to cover interest payments. At first glance, this appears to be a simple accounting trick. Moving debt from one part of the government to another does not address the root causes of the problem. But this is Argentina, where there are wheels within every wheel.

Making the move breaks the cycle of higher interest rates, which automatically leads to faster money generation, which leads to more inflation. Of course, the Treasury will have to find other ways to make payments on this additional debt to avoid default. This means even more belt tightening, which takes us back to the question of the adjustment program’s political sustainability.

Dollar vs. Peso: Can’t We All Just Get Along?

For almost 70 years, the exchange rate between Argentine currency and the U.S. dollar has played an oversized role in Argentina’s economy. Everyone – and when I say everyone, I almost mean it literally – knows at every moment the exchange value of the greenback in the unregulated market. People save in dollars and use them to make payments for just about everything. And since dollar appreciation translates directly into the cost of everything from meat to gasoline, governments usually take aim at the exchange rate in their efforts to bring down inflation.

In that regard, Milei’s approach is not so different from previous anti-inflation strategies. His exchange rate policy has two components: restrictions on who can buy and sell dollars (and how many), combined with a planned depreciation of the peso at a well-publicized rate of 2 percent per month. Argentines call the restrictions on who can buy dollars the cepo, or “lock.”

In addition to the “official” exchange rate, there is also a parallel market with at least four “free” rates in which “blue dollars” can be purchased. In mid-July 2024 these free rates hovered around 1,500 pesos per dollar, meaning that the premium over the official regulated rate (900 pesos per U.S. dollar as I am writing this article) exceeded 60 percent, up from about 30 percent in April.

Many Argentine economists – notably, Carlos Rodríguez, a widely respected former Treasury official – have argued that sustainable stabilization will not occur unless the cepo is lifted and an across-the-board free market for dollars is instituted. When that happens, they say, prices will provide the correct signals to market participants and economic activity will rebound.

One of the greatest concerns among independent economists is the differential between the predetermined 2 percent per month rate of increase of the dollar and the rate of inflation, which in the past few months has been approximately 4 percent per month. The main implication of this divergence is that domestic prices and costs increase at a much faster pace than the return obtained by exporters, who must convert foreign earnings at a rate that reflects the rigid 2 percent sliding parity.

This in turn implies that Argentine exports – grains, meat, vehicles, oil and gas – are becoming less competitive in the global marketplace. If this persists, the peso will become seriously overvalued at the official rate, and a new currency crisis will likely ensue. Knowing when to abandon the sliding parity regime is one of the greatest challenges Milei faces, and no one knows what he has in mind.

Many observers are cringing because the situation seems all too familiar. In the past, Argentina has more than once deliberately prevented the currency from devaluing at a pace equal to the ongoing rate of inflation – and regretted it. This was done in the early 1980s under the guidance of Minister of Economics José Martínez de Hoz and in the 2000s, when the minister was Harvard-educated Domingo Cavallo. In both cases, the experiment ended in a mega-crisis that had profound social, financial and political repercussions.

During the first half of 2024, Argentina’s central bank was a net buyer of foreign exchange (i.e., U.S. dollars). This was needed to replenish international reserves, which in the previous November had reached an all-time low of $17 billion. (The last time the cupboard was allowed to empty was in the second half of 2023, when the populist president Alberto Fernández was trying to have his candidate elected to succeed him.) And without a healthy quantity of foreign currency socked away, it would be very difficult to eliminate exchange controls, floating the currency and moving to the next stages of Milei’s planned recovery program.

By the end of June 2024, the stock of foreign currency reserves had climbed to $24.5 billion. This was significant progress, but still short of what mainstream experts think is required to succeed in the stabilization plan. Then in mid-July, the minister of economics announced that the central bank would stop printing pesos. It will, however, continue to accumulate international reserves by purchasing dollars at the official exchange rate.

The Dollarization That Wasn’t

In his classic 1848 treatise Principles of Political Economy, John Stuart Mill wrote about the inefficiency of the international currency exchange rate system:

So much of barbarism, however, still remains in the transactions of the most civilized nations, that almost every country has a different currency from all the rest; that every foreign payment requires to be made in the precious metals; and that consequently every country, in order to have the means of making such payments, must keep a stock of the precious metals, which is so much dead capital, withdrawn from productive employment.

Replace “precious metal” with “convertible currency” or “U.S. dollars” and you have an accurate description of how the global economy operates in 2024, almost 180 years after Mill wrote those lines.

During the 2023 presidential campaign, Milei said time and again that since the central bank had failed miserably in its duty to maintain price stability, he was going to shutter it. Argentina would follow the lead of a few other countries in Latin America – Panama, Ecuador and El Salvador – adopting the dollar as legal tender. This was not a new idea in Argentina. It was discussed seriously during the early 2000s, as it became increasingly clear Cavallo’s plan that had fixed the value of the peso at one dollar was faltering.

At that time, some economists opined that instead of abandoning convertibility by devaluing the currency, Argentina should go all in and adopt the dollar as its own. The rationale was clear: another devaluation would be devastating for the economy, as most big debts – private and public – were denominated in dollars. So devaluation would mean a proportional jump in liabilities and in the bankruptcy of scores of businesses, banks and farms.

In addition, the argument went, there was ample evidence that when given free rein, the central bank would eventually succumb to political pressure and finance the deficit by printing money. This had led to runaway inflation in the past, so abolishing the central bank in favor of dollarization would be a net gain for the nation.

Those who opposed dollarization noted that it was hardly a panacea. There were costs involved. For starters, Argentina would stop collecting “seignorage,” the income associated with central banks’ ability to create domestic money out of thin air and buy goods and services with it. If the greenback was adopted, that seignorage would shift to the U.S. Treasury. A second cost: Lacking its own currency, Argentina would give up the ability
to use monetary expansion to offset negative external shocks such as declines in export prices or hikes in international interest rates.

The discussion on whether to dollarize subsequently ricocheted around Argentina’s chattering classes until it became evident that giving up the national currency, even if almost no one wanted to hold it, was not politically possible. However, the idea lingered in the minds of some economists, including Javier Milei, who, as noted, brought it up during his run for the presidency. Once elected, though, it became evident that dollarization was not his priority.

The main reason was that the government did not have enough dollars to buy back all the pesos in circulation. This, however, does not mean Milei has completely given up on the idea. What seems to be clear for now is that his team is comfortable with dollars and pesos circulating side by side. Such dual-currency systems are not a new invention. In fact, a dual currency of sorts (gold and silver) existed in the U.S. until 1873, when silver was demonetized.

For most of his career, Friedman argued that a bimetallic system was inefficient and should be avoided. He eventually changed his mind, though, writing in 1990 that “far from being a thoroughly discredited fallacy, bimetallism has much to recommend it on theoretical, practical and historical grounds.”

Friedman also had views regarding the preferred exchange rate regime for a country in Argentina’s shoes. He argued that, while market-determined exchange rates were optimal for advanced countries, emerging nations would be better off adopting irrevocable pegs. Such a regime would give middle-
income countries much-needed monetary stability. But for this system to work, Friedman declared, the central banks of the countries in question would have to be abolished.

Picking a Fight with the IMF

Milei’s problem is bigger than reconstructing Argentina’s fiscal and monetary policy to allow for economic growth along with price stability. He must deal with Argentina’s dreary legacy of borrowing huge sums abroad and attempting to walk away when managing foreign debts clashed with domestic objectives. And, here, a bit of history may add some insight into where Milei is heading.

Between 2001 and 2016, Argentina was involved in one of the largest sovereign debt restructurings in the history of global financial markets. In 2001, when the one-peso-one-dollar convertibility experiment collapsed, Argentina defaulted on almost $100 billion in bonds, froze bank deposits and retroactively changed the currency required to fulfill private contract obligations from dollars to pesos. President Fernando de la Rúa resigned, and a succession of interim heads of state followed in rapid succession. The economy tanked, unemployment skyrocketed and the number of people living below the poverty line increased several-fold.

After intense negotiations, Argentina offered its creditors 25 cents on the dollar in 2005 – a shocking “haircut” even for speculators expecting to get back less than 100 percent. Yet, given the high costs of legal action (and dimmed prospects of squeezing blood from Argentina’s proverbial stones), 72 percent of the bondholders accepted the offer. However, a small number, including some very large hedge funds, refused the offer and launched litigation claiming full payment in different courts around the world including in the Southern District of New York. The lead holdout was Elliott Management, whose founder and senior partner was legendary hardball investor Peter Singer.

In 2012, lawyers for Elliott asked Judge Thomas Griesa in New York to block Argentina’s payments to those creditors who had settled in 2005 and 2010. They argued that payments should only resume if Argentina paid back Elliott in full. The judge agreed, and Argentina faced two choices: it could either make Elliott whole and continue payments to investors who had accepted the haircut, or it could refuse to pay Elliott and default on all creditors. Faced with this dilemma, in 2014 Argentina decided to default yet again.

Global investors were dismayed, the IMF was disappointed and in global financial circles Argentina was branded a recalcitrant deadbeat. The litigation went on in the spirit of BleakHouse until a new government led by Presi-
dent Mauricio Macri decided to settle in 2016.

President Macri appointed Luis Caputo, an economist and former trader at JP Morgan and Deutsche Bank, as the Republic’s negotiator. After a long, complex and at times brinksman-like process, Caputo cut a deal with the holdouts. Argentina agreed to pay investors owning the old debt $4.4 billion, significantly less than the face-value legal claim of $5.9
billion.

In global finance, memories can be short when the prospect of profit looms. As soon as the agreement was announced, Argentina was again able to sell bonds denominated in hard currency – and at prices above par! Many analysts asked themselves if market participants had already forgotten to whom they were lending money.

This time, however, there was a difference. The bonds had a collective action clause: provisions stating that if a supermajority of holders decided to accept a restructuring offer, the offer applied to everyone. Holdouts could not disrupt the restructuring and recovery process by litigating on their own. These clauses, incidentally, are now in all bonds issued under New York State law, a positive consequence of the Argentine default of 2001.

Why this Digression Down Memory Lane?

Glad you asked. Caputo, the negotiator who was able to strike a deal with Elliott, is Javier Milei’s minister of economics. He faces significant challenges, but so far has navigated choppy waters adeptly. One of his more difficult tasks is to negotiate with the IMF, Argentina’s largest creditor ($43 billion). Caputo has asked to roll over that debt, arguing that during the previous Argentine administration the IMF supported irresponsible policies that fueled the jump of inflation from 5 percent to 25 percent per month. The IMF has so far taken a “not so fast” attitude and has not budged.

Milei has lost patience and has been extremely critical of the IMF’s chief of mission, Rodrigo Valdés, MIT graduate and Chile’s former minister of finance. The president has intimated that Valdés is anti-Argentina and in cahoots with leftists who want his government to fail. For now, Mr. Caputo has kept his cool, playing good cop to Milei’s bad cop. Whether he will be as successful with the IMF as he was with Elliott is still to be seen.

If economists produced reality TV shows, Argentina’s excellent adventures in economic chaos would top the ratings charts. Though richly endowed with natural resources and an educated population, the economy has long been hobbled by class warfare, fringe ideologies and opportunistic politicians. Milei fits the tradition in the sense that he is promising miracles from yet another radical makeover. But he does have the advantage of being an outsider who is not trapped by the interest-group dynamics that have dug Argentina ever deeper into a populist dead end.

Can his idiosyncratic brand of libertarianism succeed where Peronism, military dictatorship and neoliberal orthodoxy have each failed? A long shot, perhaps, but a more interesting one than business as usual.