A collective reckoning? A painful but unavoidable come-to-Jesus moment? Or continuing down an inflationary spiral?
By Bianca Fernet, Argentina, The Bubble:
Well it’s 2017. Here in Argentina we find ourselves awash in the bitter fruits that have sprung up from the seeds of austerity sown in 2016. Don’t get me wrong, it had to be done, but it’s definitely not something people are smiling about. And while inflation may have slowed in December, at 1.2 percent in a month it’s still biting pretty hard. After inflation clocked in over 40 percent for 2016, it’s hard to get excited by that slowdown.
What’s going to happen with inflation, and what does that mean for the future of Argentina’s economy? The answer may lie between two hamburger patties stuck together by mystery special sauce.
Inflation Gets Real (Not Just Nominal)
I’ve lived in Argentina for seven years, and while nominal inflation at around 30 percent annually has been the norm, that was in pesos and I was earning dollars. Big. Difference. I changed my money at the dollar blue rate, which increased somewhere in the ballpark of 10-20 percent per year. The depreciating peso value compensated partially, taking the edge off inflation’s effect on my purchasing power and thus lifestyle.
But 2016 was different. I love to cook, but every trip to the supermarket ended with me feeling like I’d just paid Whole Foods prices for a bag something Walmart wouldn’t put on the shelf. I literally paid US $38 dollars for ingredients for a spinach salad for two. Granted I included a can of palmitos, or hearts of palm, and some cheese but that’s still quite a hefty sum for a bowl of assorted leaves and plants.
Is Argentina undergoing a collective reckoning? A painful but unavoidable come-to-Jesus moment? Or is it continuing along a downward inflationary spiral?
Cheeseburgers Are The Answer (Or At Least Lend Valuable Information)
The answer to the question plaguing Argentina may lie in The Economist’s now ubiquitous Big Mac Index. Now I know McDonalds is evil, meat is murder and the youths are all Paleo these days, but bear with me. The Economist created the Big Max Index to bring to life the idea of Purchasing Power Parity (PPP), or that things should cost the same no matter where they are or what currency they are priced in.
Because it’s standardized across all McDonald’s “restaurants”, a Big Mac hamburger represents a “basket” of goods: bread, sesame seeds, tomatoes, lettuce, beef, cheese, and heart attack sauce. According to Purchasing Power Parity, a Big Mac in New York should cost the same as one in Buenos Aires. In easy math, that looks like this:
New York Big Mac = Buenos Aires Big Mac x Exchange Rate (USD/ARS)
If the Buenos Aires Big Mac is “too cheap” then the Argentine peso must be undervalued. If “too expensive”, overvalued. But Argentina’s cheeky history with the Big Mac Index goes deeper than a simple question of currency valuation.
Under former President Cristina Fernandez de Kirchner, the administration used to respond to serious economic problems by pretending they didn’t exist and intimidating anyone who said otherwise. The Big Mac was a (hilarious) consequence of this policy that provided serious perks to those of us with a sense of a humor and a love of savings. See back then, the Big Mac Index started showing the Central Bank’s Argentine peso value to be seriously OVERVALUED.
Rather than address the issue, under the semi-thuggish “suggestion” of then Commerce Secretary Guillermo Moreno, the Big Mac disappeared from the menu unless you knew to ask for it, at which point it cost about ARS $20. In 2014 at the Blue Dollar rate, you could buy a Big Mac for the equivalent of US $1.61.
At the time, I keenly observed that the clever consumer could invite that special someone in his or her life to the nearest McDonalds, buy three Big Macs, and rearrange them to create two full Triple Macs – plus bonus bread – for ARS $34.40 less than the menu price of two Triple Mac sandwiches. Take your thrifty Triple Macs to the nearest park and feed the excess bread to the ducks and voila, a tale of love in the time of inflation worthy of Argentine writer, Jorge Luis Borges himself: “To fall in love is to create a religion that has a fallible god.”
But alas, along with President Macri’s other measures aimed at turning Argentina into a serious country, it seems his Commerce Secretary has better things to do than intimidate fast food chains into sandwich price manipulation. So in one fell swoop, my go-to Triple Mac date night evaporated into thin air.
What Does The Big Mac Index Say Now?
According to the January 2017 Big Mac Index, at current exchange rates a Big Mac in Argentina costs US $3.47, which is significantly lower than it currently costs in the USA, which is US $5.06.
According to Purchasing Power Parity alone, that means the peso is undervalued by 31.5%, and should be ARS 10.87. That is the complete opposite to what direction banks are predicting, which is an exchange rate approaching 18 ARS/USD by mid 2017, and 20 ARS/USD by the end of the year. Malarkey, you say? Nay, there are two important things to take into consideration.
1. America is Great Again!
That’s right folks, Donald Trump takes office as President of the United States this Friday. Mr. Trump’s policies are expected to cause the Fed to tighten monetary policy. This, coupled with global instability, has strengthened the dollar value against emerging market and major currencies alike. The dollar is trading at a 14-year high in trade weighted terms. Because the Big Mac Index is based on the dollar value, this overstates the peso’s undervaluation.
2. Argentina’s Workers
The biggest criticism of the Big Mac Index in pure terms is that it fails to take into account the difference in the cost of labor between countries to do all of the work involved with assembling a Big Mac. From farmers to factory workers, a lot of hours of work go into serving up a standardized heart attack in a box at an affordable price.
When you adjust the Big Mac price in Argentina by income (GDP) per person, the Index predicts an exchange rate of 15.86 ARS/USD. Pretty much spot on. That also means that the difference in GDP per person between the US and Argentina is more than enough to compensate for that 31.5% nominal undervaluation.
So what’s going to happen to inflation and the peso in 2017?
The Big Mac Index tells us that the situation we’re seeing in Argentina is not just a result of toying with indicators like the exchange rate to show the people what they want.
As Argentina continues to spend more money on mainly energy subsidies and other expensive government programs than it takes in via taxes, tariffs, or raises on international capital markets, inflation will continue.
The Central Bank is targeting 1.5 percent monthly inflation for the first quarter of 2017, and 12-17 percent for the year. Private estimates forecast that inflation will reach 20 percent in 2017, and that’s likely more accurate. Why? It’s politically impossible for the government to spend less and have a reasonable chance of coming through the midterm elections in 10 months unscathed.
My advice for the first three quarters of 2017 is to buckle up, as we are in for a bumpy ride. 20 percent inflation is better than 40 percent, but it is by no means enjoyable and companies, families, and individuals are feeling the squeeze as it is.
If the midterms demonstrate stability and continuity of Macri’s policies, things should start picking up across the board. Argentina’s economy needs to grow, which requires investment and the gradual relaxation of labor laws and kafkaesque bureaucratic nightmare that accompanies even the most simple business activity.
If the midterms don’t show stability and continuity, many people might have to give up salads and Big Macs altogether. By Bianca Fernet, Argentina, The Bubble
Even in Mexico, it’s not all NAFTA’s fault. Read… Mauled by Peso Crash & Inflation, Mexico to Cut its Dependence on US Food Producers.