Three interest rate hikes in one week, to 40%, imply the first two didn’t work, and the Central Bank is not in control.
By Bianca Fernet, Argentina:
If you’re watching Argentina’s economy, it hasn’t been a banner week. This week, Argentina had to raise its key interest rate three times to keep the Argentine peso from losing even more value against the dollar. Three interest rate hikes in one week is a lot – it implies the first two didn’t work, and the Central Bank is not in control.
The interest rate currently sits at 40%. That means the Central Bank pays 40% per year on peso-denominated debt, which can imply that they expect the value of the peso to fall somewhere in the ballpark of 40% over a one year period. A year ago in April, the rate was closer to 26%. Yikes.
And the exchange rate kicked off the week at around 20.5 ARS/USD. It jumped almost to 23 ARS/USD, and is currently hovering around 21.8 ARS/USD.
This bout of currency instability was triggered by a generally bad week for emerging markets, then compounded by a tax on foreigners holding local currency short term debt instruments (LEBAC) coming into force. Emerging markets, and their currencies across the board, suffered due to a strong dollar. This relationship exists because a stronger US dollar raises fears in investors that emerging markets will be unable to repay dollar denominated debt.
While that seems like circular logic (and yes, it’s not a linear cause and effect relationship), consider this: Emerging markets are viewed as riskier for investing than countries like the United States and Western Europe. Investors accept these riskier investments in exchange for higher returns than they would get in safer jurisdictions.
When the US dollar increases in value, emerging market currencies decrease, meaning in Argentina’s case it will take increasingly more pesos to buy dollars. This then amplifies the risk that emerging markets will be unable to make payments on dollar denominated debt, causing investors to sell their emerging market investments, further amplifying the currency stress.
The timing specifically in the case of Argentina is uncannily bad. Until this week, non-residents investing in Argentina were exempt from paying the equivalent of capital gains taxes across the board, including local-currency peso-denominated central bank notes, or LEBACs. This Tuesday, this exemption on LEBACs officially no longer applied, meaning foreign holders of these notes now incur a tax equal to 5% on profits. I’ll update this article when I have an estimate of the total outflow attributable to this change.
“Some people in Argentina don’t seem to have a clear assessment of just how dangerous the economic situation was in 2015,” said Ignacio Celorrio of Alfaro Abogados, a law firm with offices in Buenos Aires, Beijing, and New York. In addition to external emerging markets conditions and the unwinding of foreign holdings in LEBACs, Celorrio noted that there has been a general sentiment for over six months that the peso may be overvalued against the US dollar. This week just happened to be when reality set in.
And right now people feel like Argentina’s government may not have control over the peso. As silly as it may seem, people feeling like an economy is in trouble can be enough to spur a crisis regardless of underlying realities. Interest rates as high as 40% mean that inflation isn’t going anywhere for a while, either.
That being said, and while I expect a great amount of pontificating from market commentators and expert economists with beards, the reality is that if any of them actually knew what was going to happen they’d be putting their money behind that position rather than ranting against economic ideologies or heads of state.
“Shock therapy is politically impossible in Argentina, and the problem with gradualism is that hard targets and promises are difficult to make. The Central Bank is making monetary policy based on fundamentals rather than creating artificial economic expansion at the expense of currency stability,” said Celorrio .
Rough week. And while nothing has really fundamentally changed between last week and now, I sure wouldn’t want to be working in the Central Bank today. By Bianca Fernet, Argentina.
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Death, taxes, Argentinian Peso devaluation, those are the certainties in life.
Heck for some people taxes are optional.
I remember that a previous government refused to pay off their bonds. That worked out well for them. The present government is dedicated to the well-being of vulture funds. I guess something didn’t work out. Good.
Good ? What do you have against Argentinia I’ve been there and they are warm wonderful people
Don’t forget a dry season for soy beans early in the year, meaning less dollars than expected were for sale. Heck Argentina is importing soy beans to meet demand. Also the dollar had been rising for over a month so the government really should have expected that the selling of “Lebacs” to avoid taxes would cause trouble.
With China putting a tariff on US Soybeans and Argentina needing to import them due to weather issues…should be a match
But think of the juicy yield on that 100 year bond!
argentina? who cares! paul singer is sharpening his knifes. as HDC already mentioned, the OPM managers do not care at all. move on, nothing to see here, and, believe me, the churrasco and the malbec are still fantastic.
I care because I live in Argentina
Macri Cambienos “change” government doesn’t get it. Macri seems to be a god here in Argentina. I suspect that there will be a shift in that thinking soon.
Kinda like Italy’s golden boys and girls going from over 40% of popular vote to less than 19% in five years and without an economic crisis (stagnations don’t count because they become “growth” by under-reporting inflation)?
Italian, Spanish, Swiss etc press were all very hot on Macri when he was elected. Just last week an Italian newspaper was breathlessly hyping Argentina’s growth rate (“predicted to rise from 2.7% in 2017 to 3.5% in 2018”), without mentioning the word “inflation” once but the love story is clearly over, like it’s over with Brazil and Venezuela.
The myth of the Latin American “Third Way”, which I think harkens back to Bolívar and San Martín, has always fascinated and dare I say blinded generations of European intellectuals, and has surely been fueled by mass emigration, chiefly to Brazil and Argentina, well into the 1950’s.
Now the descendants of those immigrants are coming back, not on vacation but looking for jobs, and as Italy’s golden boys discovered even with the help of a totally sycopahntic press you can only suspend reality for so long.
Well, on a bight note.
Fixed public union pensions will worth basically little to nothing.
So government can keep on borrowing and not worry about pension debts to slow them down.
I think Chicago, Illinois, California, Connecticut and New Jersey (etc) would love that scenario…
Pension benefits in Argentina have long been adjusted for inflation.
As an American, I have to ask …… what are “pension benefits?”
Yeah, I don’t know either :-]
Pension benefits are basically a scheme where companies take a pert of your salary and put it into a special fund. The CEO then borrows against that fund to enhance his annual bonuses. Then the company goes bankrupt.
Just imagine it as a way of giving your money to the C-Suite or politicians, based on industry.
Kinda like Social Security is adjusted for inflation?
Basically underestimate inflation by 50% and hope no one notices?
Pension benefits, I get them until I don’t. I’m in my 20th year of drawing, just lucky, but know that it might end anytime.
Back up plan in place 40 years ago by not trusting completely in the game (promise).
Just live a simpler life than your earnings and no fear, maybe at my age I’ll take my first cruise, 2-3 more to catch up to my kids.
Alas BK
Doesn’t this article beg the question of whether this could happen in the contemporary U.S.? In other words, what would it take for the U.S. economy to similarly spin so out of control?
Bill, you ponder, “question of whether thiscould happen in the contemporary U.S.?” I think it’s already started in Canada, the US, I doubt it.
Until the demand for USDollars is less than the speed at which the printing presses run.
At 40% interest speculators are also buying not just investors, and this rate of interest measures the loss of confidence that the money invested will be returned. If confidence continues to dry up, the rate of interest will continue to rise. I could even double.
Bianca, my understanding is Argentina has a 25 percent inflation rate. So now they have 25 percent inflation rate and a 40 percent interest rate? How do these numbers translate into the streets? Take us through the affects of this economic situation and how it affects an average middle-class household in Argentina. Thanks.
This is just rinse and repeat for Argentina also Mexico, Venezuela, etc. I was married for 20 years to a American borne Venezuelan, when inflation starts it usually escalates until a few zeros are dropped from the currency unit, rinse and repeat.
If you have savings in Dollars like my inlaws or gold better, you have the protection against devaluation and inflation of your currency.
I remember buying a bottle of Dom Perignom at the Costco store there in the late 80’s for about $49 when the price in the States was $70-80.
Since pricing was in crapping Bolivers my Dollars were gold. I’m sure the replacement bottle cost Costco more than $55.
….”a 25% inflation rate and 40% interest rate” are a non-sequitur together. period. My guess: it’s a 39% inflation rate, or…the 40% will be baited and switched down in hours…
WHat happened? I note Argentina has forex reserves at roughly TEN (10) percent of GDP. Not high, but not zero either. Did their imports just stop? Or…..did the currency vigilantes (Elliott capital management) bite?
* correction: “did their exports just stop”…
There exports probably didn’t drop but the value in Dollars per whatever did.
I had an Uncle who bought a one year unit in Mexical pesos in mid 70’s with a yeild of 50%. When he cashed out 6 months later he lost over 25% on the capital Dollars invested.
Inflation, when it runs, take cover and protect.
For those old enough to remember the double digit inflation in late 70’s into early 80’s, the only tool in the FED’s box was raising the prime rate ultimately to 21 1/2% if memory serves me. The pain was enormous in many ways too much enumerate, but that pain and suffering righted the ship, and the payers were mostly small business, home buyers, and those owning ARM mortgages.
The Banco Central has been selling a lot of forex reseves starting in the first half of February and sharply accelerating in late April, when they were burning through something like US$7-8 billion/week to stop the peso from free-falling. That’s a lot of money.
I suspect the Banco was surprised by the dollar’s strength in the last few weeks and had no other arrows left but selling forex reserves and pray financial markets would win their fight with the Fed.
As it usually happens the old adagio “Don’t fight the Fed” is right and the Banco Central is caught in the usual loop of having to hike interest rates to ridiculous levels without much to show for it, so having to eat through dwindling forex reserves until they just throw the towel in and let the peso sink to where it belongs. In the meantime the inflation the Banco Central itself willingly created in the first place is causing the usual havoc and mayhem.
While this is hardly surprising what’s surprising is the degree of gullibility displayed by the various analysts, investment gurus and assorted money charlatans who are buying into the Banco Central’s old and tired routine.
The worst for Argentina has not even begun and, cynically, that’s when you must buy, not now when politicians and economists are still thrashing with foreign investors as easy targets. To quote (possibly apocryphally, but in character) Richard Nixon “You have to kick them when they are down”.
Don’t we usually learn afterwards that currency speculators were manipulating the prices?
Nonsense.. speculators are either short or long a currency,, they are placing bets on which way prices will go .. for every long there is a matching short… they can not manipulate the price… of course government loves to “blame” the speculator,, which is pure nonsense.. the problem is government mismanagement..
I picture George Soros somewhere chuckling and rubbing his hands together greedily
At first blush this is true, but for the existence of naked short selling- strictly illegal for you or me- but permissible for “market-makers,” and since this includes subsidiaries of some of the too-big-to-fail banks (meaning, in extremis, the money comes out of the taxpayers’ pocket), the markets are indeed manipulated as hell.
Wealthy Argentinians selling pesos to buy dollars are not speculators. They just see the dollar going up, and know that buying dollars is easy money. So the government just has to keep jacking up interest rates to find where the folks with money want to hold Argentinian debt more than US dollars.
True. This is probably why Asean countries discovered “freezing the capital account” as panacea to their 1997 currency crisis problems. Instead Argentina went with 40% interest rates and taxes on LEBAC
Does Argentine need the money? It’s monetary sovereign and technically cannot be insolvent in its own currency. It sure can in a foreign one, but if it wants dollars it should just buy them on the spot market.
All the rest is just galopping ignorance. Everyone is an expert in that.
The worst thing that one can do in the market is get loans in foreign currencies. If you want to speculate, Fine. just enjoy the ride.
No, Argentina isn’t insolvent. No one said it was. Read the article. But its currency is collapsing and it has 25% inflation. That’s what you get when you follow your admonishment to just print the money as “monetary sovereign.” You’re destroying the currency. In 1998, 1 ARS = 1 USD. Now 1 ARS = 4.6 cents. So you can still borrow in ARS, but you’re going to pay over 40% in interest a year.
So it seems the “galloping ignorance” you mention so elegantly is on your side.
So is the galloping inflation the first sign that something is about to happen? What is the chance of a negative feedback loop, and a default on those 100-year bonds, and the consequences of money moving back to the centre?
If history is any guide, Argentina will certainly default several times on its 100-year foreign currency bonds over the next hundred years. Investors who bought them at issuance figured they could benefit from the higher yields and then sell them for a profit before the next default.
The value of those bonds has now dropped quite a bit, as investors think that the moment might be closer than they’d originally envisioned.
Money moving back to the center = private Swiss bank accounts. There, I fixed it for you.
Wolf, Argentina’s economic history is a very interesting story, as is the rest of it’s history. Argentina’s recent performance in this century has been nothing but dismal. I hope only gamblers enter the game, not those who know nothing but have a trusted advisor of some ilk.
If you have a conservative-sounding emerging-market bond fund, you likely own some fragments of these Argentinian dollar bonds :-]