The mere mention of helping Argentina – the quintessence of political chaos and serial defaulter extraordinaire – is enough to make one cringe and immediately reject the idea out of hand. The thought that ‘this time is different’ should elicit groans.
But the curious case of Javier Milei’s Argentina at least warrants deeper reflection.
Argentina’s problem has historically been overborrowing, financed by printing central bank money, which leads to hyper- or high inflation and by tapping external markets, causing default. The bloodiness of defaults weighs on psyches.
Shock therapy
To wring inflation out of the economy, Milei’s government slashed the large fiscal deficit and turned off money printing, notwithstanding the obvious near-term pain. The economy was turning around earlier this year. Inflation was way down. His team pursued liberalisation of the economy. His shock-therapy approach was right.
Where Milei went wrong was on the exchange rate regime. His original idea to dollarise was unworkable given a lack of dollars. Binding the Argentine economy to the US Federal Reserve’s credibility – even if to restore confidence – was unwise. Though Milei initially devalued the peso, the subsequent rate of crawl was insufficient relative to inflation and the currency became highly overvalued.
The government’s understandable aim was to avoid currency depreciation feeding inflationary expectations. But the use of the exchange rate as an anchor to stabilise inflation expectations has a chequered past. An exchange rate anchor can be more effective than a money-based stabilisation in impacting immediate inflation psychology, but the lack of coherent exit strategies often results in overvaluation and spectacular currency crashes.
In general, that is precisely the situation Argentina now finds itself in, exacerbated by the latest political developments, especially as it is selling reserves to support the peso ahead of the elections.
US Treasury to the rescue?
The Donald Trump administration has pledged a show of support for Milei through a $20bn Treasury Exchange Stabilization Fund ‘swap’. What should one make of such a use of US taxpayer resources?
First, ‘swap’ is a misnomer. It involves a reversible transaction, exchanging one asset (dollars) for another (pesos). That tells one nothing about the terms and conditions of transactions.
ESF credit operations have long been used – though not in recent decades – to support countries where the US has interests. Treasury Secretary Scott Bessent’s suggestion Argentina is ‘systemic’ does not, however, stand up to scrutiny.
In the past, operations were often structured as a shorter-term bridge to an International Monetary Fund disbursement. This provided confidence the concerned country was on the reform path and there was an assured source of repayment, consistent with ESF policies and statutes.
Credit operations undeniably entail risks. But the mere existence of risk is not a reason for governments to shy away. If the US is bent on undertaking such an operation, it should deploy measures to mitigate risks.
Mitigating risks
Plain and simple, Argentina needs to float the peso. Milei – even if inclined – obviously wouldn’t want to do so until after the 26 October elections. Whether he can hold out that long is another question. The Treasury should demand, on top of maintaining tough macro policies, that Argentina float immediately after the elections. It should not extend its swap beyond that time. Of course, stating this openly would trigger a run – officials must instead argue that the peso exchange rate is sustainable.
Despite the headline $20bn figure, the Treasury by no means should extend the full amount. Argentina’s reserves are running on fumes.
It’s unclear what the Treasury will use as an assured source of repayment for any credit extension, though one is absolutely necessary. As part of any ‘swap’, Argentina should also pay interest and assume all of the foreign exchange risk.
There have been reports that the US directly supported the Argentine peso in the foreign exchange market. The Treasury ESF only holds yen and euros, which might be needed in foreign exchange market intervention. It has no need whatsoever for pesos. It would be extraordinarily unwise for the Treasury to take pesos on its books without an agreement to reverse the transaction, including Argentina taking the exchange risk.
Despite talk about the $20bn swap deal and the positive announcement effects thus generated, it is not clear if an agreed legal document even exists by which the credit operation could be launched. It would be good for the Treasury to release as much information and documentation as possible to the public.
Should the US do it?
Some US Congressional representatives object to an Argentine ‘swap’ because of the risk. They also point to the fact that some financial players may be shielded from taking losses on Argentine lending, or that China is buying Argentine and not US soybeans. However, China not buying US soybeans is about Trump’s policies, and some financial players being shielded from losses is an unfortunate side effect but not a reason to avoid proceeding.
On balance, as much as the thought of helping Argentina may make one cringe, governments at times take calculated risks.
The administration appears intent on proceeding, for better or worse. If Argentina sticks with tough fiscal and monetary policy medicine, floats the peso immediately after 26 October and there is a solid, assured source of repayment, the proposed ‘swap’ could constitute a calculated risk – though one shouldn’t make light of that risk. Absent these conditions, the use of the ESF at this time for Argentina would represent an extremely unwise use of taxpayer resources.
Mark Sobel is US Chair of OMFIF.
Join OMFIF on 16 October to examine the outlook for US fiscal policy roundtable.
Image Source: The White House
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