Argentina’s new forex policy in three words: Stupid, Stupid, Stupid

Here are a few two year charts that map how some local currencies have done against the dollar.Here’s the Brazilian Real (approx 20% appreciation)


The Chilean Peso (approx 18% appreciation)


Here’s the Colombian Peso (approx 10% in two years, but 23% from that peak)


Now the Peruvian Nuevo Sol (approx 16% appreciation)


And to give some global context, here’s the Euro’s perf against the greenback in the same two year period (approx 21% appreciation)


Meanwhile, Argentina’s Peso has done…well….this;


While the vast majority of world currencies have appreciated considerably against the US Dollar, the Peso in Argentina has actually lost ground against the greenback to the tune of around 2%.

We’ve been through the “whys” of this monetary policy before, but in a nutshell Argentina wants to keep its currency artificially weak so that its exports remain competitive. The fact that it doesn’t necessarily change anything (We’ve previously argued that one as well (1)) doesn’t seem to worry them….so be it.

We also argued that Argentina is setting itself up for a speculative attack on its currency from overseas investors. Peru is the latest regional state to have made the complaint that foreign hot money has been washing in and overcooking its forex market. Well, it looks like Argentina has not just ignored this threat but has just thrown the door wide open to the speculators and pinned a sign saying “please take my money” on its back.

Bloomberg reported today (2) that Martin Lousteau, Argentina’s minister of the economy, plans to sell ArgP$40Bn into the foreign currency markets this year to keep the Peso weak. But this time they aren’t just going to emit Peso debt but use tax revenue pesos to buy the dollars, the idea being that they can artificially weaken the currency without printing more currency and adding to the country’s inflation problem (and hey, it’s a problem).

Sounds fine, no? You get to 1) up your dollar reserves, 2) keep your currency nice and weak and where you want it and 3) don’t add to M2 in pesos, thus lessening monetary inflation pressures.

Well, apart from the obvious inflation problem a weak currency causes to a country with a strongly growing GDP (country gets richer, country likes that 42″ flatscreen digital TV they make in Japan, country starts importing shiploads of stuff, country pays through the nose for foreign goods in its local currency cos the gov’t won’t let the Peso go from 3.15 to 2.80 vs the dollar etc etc), the chances of being hung out to dry are multiplied tenfold when you start playing forex games in the big leagues instead of just pumping out the pesos to the unsuspecting locals and sterilizing the transaction.

How it happens is like this: Argentina wants to sell ArgP$40Bn in a year…that’s ArgP$3.33 a month…let’s call it a billion dollars’ worth to round up a bit. So Argentina trots over to the open forex market and finds a buyer for its pesos. Ka-ching, dollars change into pesos at 3.15/1, and everybody’s happy.

But hold on a minute; if you were the buyer, what would be the attraction in buying a currency that wasn’t planning on going up in value? Surely you’d be a buyer in the Peso for a reason, no? You’d like the Peso and happily sell your dollars if you thought it would get more valuable later.

So what happens if you, as Señor Buyer, decide that you don’t just like the Peso but you REALLY like the Peso? The Argentina government goes to market and sells its ArgP$3.33Bn for the month, and you go, “Hey! wait up dudes!! I haven’t finished buying those yet! Don’t run away, sell me another 3 billion, yeah?”

Argentina says, “Sorry dude, ain’t got no more right now….I’ll sell you a few next month ok?” Señor Buyer, “Hey dude, that’s bogus. Anyone else wanna sell me some?” Private bank #1; “Yeah, I got 500 million of them, but I won’t sell ’em so cheap. I’ll give you 3.1 of them for a buck.” Señor buyer, “Yeah ok, it’s a deal.” Private bank #2; “Dude, you can have half a billion of my Pesos at 3.05 if you like, yeah?” Señor buyer; “Cool, deal…here’s the moolah.”

Now all this time Señor Buyer’s feeling happy, cos he bought 3.3Bn pesos at 3.15, then managed to bring down the exchange rate by buying a few more at lower prices. So if he cashes in his original buy at the latest deal price of 3.05, he makes 10c on every Peso he bought from the gov’t. And when you’re talking 10c X 3.3Bn, that’s a tasty profit.

But the gov’t aren’t so happy, they see what’s been going on since they left the market and go, “WHOAAAA! Bad karma, maaaaaan! This whole thing was supposed to keep the Peso weak, and now look what’s happening…DARNIT! We’re gonna have to sell some more Pesos.”

So the gov’t goes back to market and sells another 3 billion or so. But Señor Buyer isn’t just any old buyer with a deep pocket. He’s a hedge fund with REALLY deep pockets and he’s got pals who run funds too, and he smells serious profits here.

Señor Buyer; “Hey, this is SOOOO cool. These dudes are selling me lumps of cheap currency, but not only that, they’ve already told me how much they’re going to throw at me in the whole year. They have ArgP$40Bn to sell. Hold on, let me check how much I’ve got here. Okaaaay! Way cool. I’ve got TWO HUNDRED AND FIFTY BILLION DOLLARS HANGING ROUND HERE! All I have to do is buy every single cheap Peso the Argentine gov’t offers me, then buy more and more and more until they can’t defend it any more! Sweet! Then it goes to 2.80 or so, up 10% more or less, and I cash in my chips….They sell me 40 billion chips and i make a 4 billion chip profit without breaking sweat.”


Moral: Argentina is now officially playing with fire. It doesn’t take Einstein to work out that the Peso is lagging behind all other regional currencies (check those charts again), and by going to the open foreign exchange market with a fixed amount of Pesos to sell they are making a huge tactical mistake. The well-founded word on the street a couple of weeks ago was that economy minister Lousteau was very close to resigning. When the forex market has finished with him and his half-baked plan, he might just get fired first.





5 Responses to "Argentina’s new forex policy in three words: Stupid, Stupid, Stupid"

  1. Guest   March 14, 2008 at 11:17 am

    Very interesting.But isn’t the Central Bank still going to be around when the treasury decides it has sold enough pesos? They don’t care about inflation.

  2. Brian Shriver   March 14, 2008 at 1:19 pm

    For what it’s worth, if I were in their shoes, I would do basically the same thing. First Japan, then other Asian countries and now China have shown the value of an export-led development strategy. An important (and stabilizing) part of this strategy is keeping your currency a bit undervalued relative to “trade balance parity” to give your exporters a leg up. If consumers can’t afford their new flat-panel television sets — well sacrifices have to be made to put the country on a solid economic foundation.The only, in my opinion, legitimate point you make is the problem of local money supply. Japan and now China clearly demonstrate both the costs of this strategy and short-term measures that can be used to reduce or delay the impact.On balance, however, the benefits of a competitive forex policy significantly outweigh the drawbacks. If other South American countries don’t understand this, well – they’ll learn soon enough.

  3. Alejandro   March 14, 2008 at 1:42 pm

    Mark,I think once again ((1)) you are missing the point. Regarding (1), if you just look at the trade balance between the two countries you do not understand what the government is trying to accomplish with a competitive real exchange rate policy. If the only think that matters is the trade balance, then how do you explain me the different rates of growth that we observed lately in both countries? The fx policy is the main responsible for that gap and its impact is spread out in the entire economy. It’s like you are just focusing on partial equilibrium analysis.This post has some appeal but I think it is still not clear to me that it is such a slam dunk for foreign investors with deep pockets. First, if it were so obvious as you just described and markets of course are very good at correcting this type of “inefficiencies”, what they are waiting for? Why we haven’t seen a run so far given that this policy has been out there for quite a while? Rest assured that once you became aware of this trade and presented here as if it were such a simple killing, there are plenty of funds which looked at this way before you illuminate them and either tried unsucessfully or didn’t even bother. So go ahead or search for funding so you can exploit it, be my guest. Second, following your example, how are you going to cash in your original buy at 3.05? It’s a killing for the private bank but not for the investor who doesn’t find any way to make profits on his first buy unless there’s a massive stampede as you are predicting. Third, with the existing levels of risk aversion and mounting losses everywhere, I doubt that any big hedge fund is so eager to jump to this “great opportunity”. Moreover when this whole mess is over I can imagine a lot of “obvious” trades that are without question more appealing that this one. This of course gives the government time to keep pursuing the right exchange policy which is obviously in the interest of Argentina.I agree that they must contain inflation because otherwise they will still get the real appreciation anyway. They need tighter monetary and fiscal policies to support their exchange rate program (among others, this is a crucial mistake). Unfortunately, they are not doing anything on that front. But that is a separate post altogether.

  4. mark turner   March 17, 2008 at 9:10 am

    thanks for the comments, people.It’s obvious that i’m outlining a ‘trade’ here, but that’s not really the reason why the post is on an economic blog. Brian and Alejandro, your comments are fair enough but are subjective opinions, and we can play “good trade bad trade” all day without much point to it.I’d say this much, though: do you really think the Argentine policy of selling a potentially strong currency and buying the Dollar is wise? The reserves level of U$50Bn just announced may sound impressive, but how’s the evolution of that reserve when counted in Euros? Or gold? Or soybeans, for that matter!Again, thanks for the comments; always appreciated to hear different views

  5. Brian McMahon   March 19, 2008 at 8:12 am

    One of the biggest problems in analyzing the Argentine economy from outside is the difficulty of grasping the relevant variables and their relative importance. I suggest that you examine the components of tax revenue, paying special attention to the contribution of export taxes to the attainment of a fiscal “surplus” and their effects on inflation. Second, look into who’s economic and political interests are being served by these policies. Third, consider the true inflation rate (estimated at around 20-25% last year. Fourth, excluding the 1990s, analyze the repetitive Argentine business cycles under import substitution (the stop-and-go cycles and their causes). I think you will see that, while seemingly correct, you made some grave errors in your assumptions.