What could go wrong?

The peril of Milei

Javier Milei is coming to New York today! To visit … uh … Menachem Schneerson’s tomb? OK, that was not expected.

Anyway, we started writing an explainer about all the things that could go wrong with a Milei administration before the election, but it somehow got buried. But better late than never! With him visiting our fair city, it’s time to post.

This blog has argued that the next president has an opportunity to reform Argentina. As long as they don’t muck up the needed adjustment, they’re facing some pretty good years.

But how could it go wrong?

1. Milei refuses to default. The budget numbers don’t add up under any reasonable adjustment unless the federal government suspends the 1.8% of GDP (and rising, as the peso falls) that it pays in debt interest. If a Milei administration refuses to default, then he will turn into an Argentine version of Nicolae Ceaușescu. Bad things will follow.

2. He botches deals with the opposition. It is true that the Argentine president possesses an astonishing amount of legislative authority. But president isn’t a dictator. For example, it is hard to stop a presidential decree but a sufficiently energized and unified Congressional leadership can do it. As long as the Joint Standing Committee is kept in session and enough members show up, it can block the President. Similarly, Milei could easily find that his attempts to call referendums on his policies backfires. Sustained conflict between the President and Congress could morph into a terrible ground war and cause the economic crisis to metasticize.

3. Strikes and protests. The Peronists can bring people out onto the streets. Milei could easily antagonize them to the point where they choose to try to use strikes and protests to bring him down. This didn’t happen to President Macri, but Macri is a charming and avuncular political animal. Milei is …

   The Unidad Piquetera has already announced that will take to the streets on November 28th, and again on December 19th and 20th.

4. He fails to anchor the exchange rate. Why did Macri fail? Well, the conventional wisdom is twofold. First, Macri slashed taxes with abandon, widening the fiscal deficit.¹ Second, he ignored the exchange rate, relying entirely on inflation targeting to bring rising prices under control. When Gabriel Palazzo, Martín Rapetti, and Joaquín Waldman took a look at the last 46 inflation stabilization plans in Latin America, they found that all the successful plans included three elements: a big fiscal adjustment (i.e., the government’s debt burden stopped growing), a big balance-of-payments adjustment (i.e., the private sector also stopped borrowing from abroad), and an exchange-rate target. But stabilizing the exchange rate appears to be merely necessary—it is not sufficient and it is not easy. 29 of the 46 plans tried to use the exchange rate to bring down inflation … and 17 of them failed.

   If he sticks with a dollarization plan that can only work if the peso collapses in value beforehand, then he will be setting Argentina up for failure. If he tries something more conventional, say a version of the Brazil’s 1994 real plan, then success is by no means assured.

5. The “leliqs” blow up. Inflation is high in Argentina because the central bank (Banco Central de la República Argentina, or BCRA) has been printing money to finance government spending. But it is not as if the BCRA has done nothing to try to slow down the price hikes! In order to get pesos out of circulation, it’s issued debt. The banks buy that debt, handing pesos back to the BCRA and getting them out of circulation. The bonds are called “Letras de Liquidez,” or leliqs for short.

   The problem is that in order to get the banks to buy the leliqs, the BCRA needs to pay interest. Very high interest. (133% annualized at the last auction.) Which it does by printing money. So a scheme that started as a way to keep inflation under control is now adding to it, a 23 trillion peso time bomb.

   How can you get out of this mess? Well, one way it to just stop issuing them. Roll over the principal and stop. Right now, in fact, the banks are worried that the BCRA might do just that so they are switching from leliqs to even shorter-term central bank debt. But because there is demand for that debt, the central bank is terrified that if it just stops lending to the banks, then they won’t be able to pay any interest to depositors, and the financial system will collapse.

   Another way is to arrange a debt swap: switch out the leliqs for longer-term debt, preferably issued by the Treasury, at lower interest rates. But doing that is just as tough as it sounds. It is a job for a highly-trained and extremely-charming (for banker values of “charming”) technocrat.

So while Milei has a shot, all of this could go quite spectacularly wrong if he doesn’t handle it well. Good luck.

1. Ironically, and sadly for Argentina, the markets didn’t immediately punish Argentine bonds the way they immediately beat up the United Kingdom when Liz Truss tried the same thing.