Shrinkage?

The winter weather’s not the only thing chilling the bones of Argentina’s residents –  Since the last week of July, a new set of words have been showing up in the articles about the economy.  Shrinks.  Slows.  Stagflation.  These chilling terms are being used to describe the consequences of what some pretty nasty looking economic indicators might have in store.

On July 26, Citigroup reported that Argentina’s gross domestic product will post its first annual contraction in a decade.  Economists estimate that GDP will shrink approximately 1.7% this year.

The same week, the official government statistics bureau INDEC reported that May economic activity fell .5% year on year, while private economists estimated the fall to be closer to 1.2% and predicted the June drop to be close to 3.9%.  Check out this article to read more about these numbers.

image credit: ichigomarshmallow at http://ichigomarshmallow.deviantart.com/art/Fat-Deer-268283005

NOT Stagflation

Now, enter stagflation.  For those of you that weren’t alive or were busy eating crayons in the 1980s, stagflation describes a situation with:

  • Persistently high inflation:
  • Low and slowing economic growth
  • Steadily high unemployment

 

 

 

 

This specifically nasty combination of factors earns the name stagflation because it presents policy makers with a dilemma.  Steps that could hem in inflation would actually exacerbate low growth and unemployment, and vice versa.  Essentially, the government is presented with three problems, and fixing one would make the other two worse.

A Trilemma: Try to fix one problem and the other two get worse

While stagflation can be brought on by a large external shock, à la the oil shocks of the 1970s, Argentina’s situation is the result of over a decade of pursuing a growth strategy that combines import restrictions with capital controls to promote domestic growth and high employment.

In 2001 when Argentina opted to default on international obligations and rapidly devalue the peso, effectively losing the ability to borrow money abroad, they did so to pursue a course of action without the harsh effects of austerity currently being protested in Greece and Spain.  And indeed, the past decade has seen growth and relative stability, which led a number of commentators to suggest that Argentina provides an alternative path to countries under strain in the Eurozone.  (See here, here, and here.)

Image Credit: Europa.eu

This isn’t a shock yet

The emergence of stagflation in Argentina should serve as a warning to these thinkers.  While some will surely argue that stagflation has been brought on by external factors including the Eurozone crisis and the United States’ continuing faltering, these are factors not shocks.  Furthermore, if Argentina’s economy is stumbling now, what will happen if these drawn out first world crises do indeed develop into full blown shocks?

While the situation is certainly complex and could spawn countless studies and articles looking at the social benefits Argentina has accrued as a result of following this particular growth strategy, it looks to me like the point of unsustainability has pretty clearly been reached.

When Argentina devalued the peso in 2001, it became de facto more competitive on the export market.  Policies were put in place that did in fact support the growth of service and industrial sectors.

But what do growth and competitiveness at the expense of sustainability mean?  The price of a cup of coffee in Buenos Aires might be the only thing it has in common with Paris these days; meanwhile, the streets are rocked on a daily basis by protests and transportation stoppages that exacerbate a pervasive air of creeping downturn.

Photo Credit: La Nacion

The subway strike continues

In addition to donning winter gear, Argentines are battening down the hatches against what is to come.

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21 Responses to Shrinkage?

  1. Laura Graham says:

    Good blog post. But, I disagree with your contention that Argentina should be a warning. If you focus only on Argentina, you are right there are many problems; cultural, economic, social, you name it. Yet, relative to the global context, Argentina should serve as lesson to those European countries suffering because they relinquished their monetary policy to the European Union.

    Argentina is in a much better situation than most other countries and especially in comparison to the crises they had to face when the peso was pegged to the dollar. In 1998, with the devaluation of the Brazilian Real (Argentina’s main trading partner), Argentina was unable to react because it was stuck to the 1 to 1 peso-dollar system, much like what has happened with Spain, Ireland, Italy, Greece in their current situations.

    Without full control of its monetary policy, Argentina lost its competitiveness, causing it to build up up an enormous debt. Four years after 1998, its GDP declined by nearly 20, unemployment reached 25%, and its Debt to GDP ratio exploded to 165%
    .
    Now, 10 years after regaining control of their monetary policy, its debt to GDP ratio is 42% of GDP, its unemployment is 7.2%, and it has been growing on average 8% per year. Though, it stumbled in 2008 in reaction to external factors, it picked itself back up and continued growing. It is now 2012 and it is stumbling again due to mainly external factors, but it will be able to pick itself back up again. Why, you may ask?

    Argentina is in control of its monetary policy and has a low debt obligation, unlike many other countries in the European Union. This has allowed them to finally have the freedom to use the central bank to pay off its debt, to devalue its currency and to promote policies of growth and expansion. Yes, there maybe stagflation in the short term, but they have room to maneuver, which they didn’t have before and many countries around the world do not have at all.

    This is a macroeconomic example that many countries on the point of default should consider following, though I hope they do avoid emulating the cultural one of protesting over every damn thing.

    • Hi Laura!

      Great comment – one question though. You contend that Argentina is suffering “due to mainly external factors”. While the global economy is a unarguably a bit wobbly, what external factors are you pointing to?

      Does your assessment take into account the close to 30% annual inflation rate?

      Thanks for commenting and keep reading!

      Bianca

    • Thanks Laura

      If you (and David) are right, come visit me in 2013 and I will buy you each a bottle of wine with my less worthless pesos 🙂

  2. David Chu says:

    Hi Laura and Bianca!

    While I am not a trained economist, I am a student of economics and finances, an amateur economist if you will. Because to be financially and economically unaware during these uncertain times (like the Argentineans just before 2001 crash and the Greeks, Spaniards, and Italians now) is to allow oneself to be financial roadkill! I live in northern Patagonia and have been in Argentina for some 3 years now.

    Great blog, Bianca! I am going to keep reading your wonderful and insightful posts!

    In answer to your question about the external causes of the huge inflation rate in Argentina (~25% per year), part of it is caused by the surplus of USDs due to the trade surpluses that Argentina has experienced over the past 10 years or so. Basically, Argentina’s central bank buys up all the excess USDs to maintain the peso’s value relative to the USD, as all the export-driven countries are doing. To do so, they literally print even more pesos (so much pesos that they have to be printed in Brazil!) and that gets injected into the local Argentinean economy. Monetary inflation first, which then is followed by price inflation in an insulated economy like Argentina.

    I think that this factor is probably contributing around 16% of the 25% inflation rate. How did I arrive at this figure? The exchange rate between the peso and the USD has “increased” from 3 to 1 in August 2008 to 5 to 1 today (August 2012). This is an appreciation of the cost of buying USDs of about 16% per year over the past 4 years (think of the USD as an iPhone). The other part of the inflation equation are the internal forces, i.e., strong labor unions demanding and getting 20+% increases in salaries and wages, and the psychology of the Argentineans who have experienced financial crashes every 10 years or so.

    I wrote an article in November 2010 called “Currency Wars For Dummies: How the United States is Hyperventilating the World” that you might want to check out: http://d1161650.domain.com/currency_wars_for_dummies.pdf

    Argentina has the classic factors that lead to inflation and, God forbid, hyperinflation. It’s kind of the chicken and egg thing. Monetary inflation which leads to price inflation which leads to wage increases, and so forth and so on.

    One of the main reasons why the EEUU is not experiencing huge inflation right now is because the labor market, what’s left of it, is in no condition to demand higher wages. Everyone with a job is worried about keeping that job, rather than risking being fired or getting laid off.

    And Laura, I agree with you that Argentina is in much better shape to survive and, possibly, even thrive during this Greatest Depression (Gerald Celente coined this term) or Great Depression 2 that we are living in. The current situations in Greece and Spain are far more dire than Argentina was during its 2001 crash. The tremendous natural resources of Argentina should be a great buffer and support for this beautiful country–if the Argentineans don’t screw it up royally!

    Argentina still manufactures goods like washing machines and refrigerators, and has not allowed globalization (the externalization of greed on a global scale in search of slave labor wages) to decimate the local economy, as is the case in EEUU. This will help.

    But the $64 million question is when the tsunami from the EU and EEUU collapses hit this shore, how will Argentina and her people fare?

    David Chu

  3. Laura Graham says:

    Hi Bianca!

    The external factors are the following:

    1.The sharp slowdown in Brazil (Argentina’s largest trading partner) which accounts for 21.8% of Argentina’s exports. Look at this article for more information:

    http://online.wsj.com/article/SB10001424052702304821304577440653246663584.html

    You know how they say when the U.S. sneezes; the rest of the world gets a cold, well this is a perfect example of the relationship between Brazil and Argentina.

    2. Global warming-drought in Argentina for the 2011-2012 season. Soy exports were 20% lower in comparison to the past year.

    If you take these two external factors into account you can see why Argentina is facing a slowdown. With Argentine industrial goods accounting for over 30 % of Argentine exports and agricultural goods (including processed foods) accounting for over 50% of exports – combined they account for 80% of its exports. It makes sense why Argentina is having a sharp downturn.

    INFLATION:

    Yes, Argentina’s inflation is a disaster but it is not the cause of the downturn, though it is aggravating it. As David Chu pointed out, the government has been buying dollars of the market to meet its foreign debt obligations. It furthermore has implemented currency controls, import restrictions, and an expansionary monetary policy in response to the falling revenue from exports to insure they have enough dollars to pay the debt at the same time trying to maintain growth. This is a difficult and costly balancing act.

    It probably would have made more sense to have tackled inflation in 2007, when it started to become a major problem. But, it is a choice this populist government made by choosing higher growth rates over fighting inflation. I am not an apologist for the Argentine government, but I understand their inflationary dilemma

    Also, just as David said, there is now a huge psychological factor involved, where everyone is in a race to increase wages and prices to get ahead of the expected inflation. This creates a staggered effect, first the taxi union asks for a 25% hike, then the bus drivers, then the insurance companies, etc. This has transformed into a never ending cycle.

    In order to stop this situation, the Kirchner government needs more than monetary policy responses; it needs the political will to say NO to the labor unions asking for wage increases around 25%. The people may suffer in the short to medium term, but it is necessary in order to start tackling inflation. Unfortunately, I don’t think the Kirchner government wants to spend its remaining political capital in a tug of war fight with the labor unions. They have tried to undermine the power of main labor union boss Moyano, but it seems to have backfired.

    So, I agree that inflation is a factor in Argentina’s instability but it is not the cause of the downturn.

    Furthermore, I believe Argentina has a high chance of climbing out of this because of a rise in global agricultural product prices, a potential for a successful 2012-2013 harvest and a third quarter rebound in the Brazilian economy being estimated by many economists.

    Those are my two cents on the matter. Cheers everyone!

    • David Chu says:

      Hi Laura!

      You really know your stats on Argentina. Do you have a blog yourself? Or do you write for some publication? I don’t really have one, but will probably create one soon.

      It doesn’t help when the head of Argentina’s central bank makes a public statement recently that printing money does not create inflation! The primary purpose of buying the excess USD is to devalue the Argentinean peso to make it competitive (what China and every major export-driven country are doing against the massive printing and exporting of the USD by the Yankees), besides having a reserve to pay off its illegitimate debts (the old IMF/WB economic hitmen model of “privatize profits, socialize debts” that is being practiced on Greece, Spain, Ireland, Italy, etc.).

      I don’t share the optimism that Brazil’s economy is going to rebound any time soon. I wonder if anyone knows how much of Argentina’s exports goes to China (soya, corn, etc.) Because China is also slowing down.

      It doesn’t look good for 2013.

      So, Bianca: Better buy that fine bottle(s) of Mendoza wine before y/our worthless pesos tank even further in 2013!

      • Laura Graham says:

        Hi David,

        No, I don’t have a blog myself yet. But, I’m thinking of beginning one.

        7.2% of exports go to China (second biggest trading partner) in comparison to 21% going to Brazil. I don’t think the demand for agriculture products will recede. Though, there is a good chance Brazil may continue to stagnate, but that depends on global factors.

        Bianca- the Peso will continue to become more worthless, it will slowly devalue until it finally meets the decreasing blue rate. That is the government policy. So, as David said it might be better to buy that wine now.

    • Laura says:

      “The architect of Argentina’s economic radicalization, neo-Marxist Axel Kicilloff, often labels critics as “reactionaries” while praising Keynesian aggregate demand management. “. I love how the wsj calls a leftist Keynesian economist , a marxist. Good old Rupert Murdoch, his editorial changes are always fantastic after a take over.

      • To be fair Laura, many media outlets describe Kicillof as a Marxist. http://es.wikipedia.org/wiki/Axel_Kicillof

      • Laura says:

        True, but lanacion is anti-Government and so is El cronista. And the wsj allows inaccurate statements that have been written about killicof to be published because it suits their purpose. I don’t think it’s fair to call someone a Marxist just because he wrote a paper redefining marx’s theory of abstract labour.

        http://www.highbeam.com/doc/1G1-229896441.html

        it’s the inaccurate and unfair portrayal for alteriors purposes that gets me. Its there to instill fear and rejection, instead of the Truth. Kind of similar to how fox news is run.

        At the same time, I don’t usuallly agree with pagina/12 (argentine leftist paper) portrayal of events because it is has become dogmatic and always has to support the gov.

        But I guess that is the state of the media today. That’s why I’m glad you’re writing this blog. Firsthand primary experiences with accurate information are so valuable. It’s much better than reading the same associated press article in various different news outlets, over and over again.

  4. Amparo CV says:

    This government doesn’t care at all the costs for the people. People is starving THAT’S A FACT, and more and more people will be unable to buy the substantial goods for their survival. I don’t care about Macroeconomy as the conclusion can be change as well as the perspective you use to analyze the situation. We have African salaries and costs more expensive than Europe or USA. Even worst the industrial and manufacturing is stopping their production, as we have no raw materials and almost all were imported, the syndicates pressure for increasing salaries, while the middle class has no job and no money in their saving to spent. This is even worst prognostic than we had in the 2001. The State is controlling things they don’t even understand how they work, printing bill with Ciccone, their personal friend, controlling all the dollars in the market, we are living a economical and political dictatory. We as a country were used as lab- rats. and then they apply the same plan with Europe, look the results they got, the same we had 10 years ago. Well, we are 10 years in advance for something: disaster.

  5. Gabriel says:

    Bravo! Great post. David, Laura, you should join Bianca as writers on Not Paris!

  6. Just one remark to Laura’s comment: “Argentina is in control of its monetary policy and has a low debt obligation, unlike many other countries in the European Union. This has allowed them to finally have the freedom to use the central bank to pay off its debt, to devalue its currency and to promote policies of growth and expansion. Yes, there maybe stagflation in the short term, but they have room to maneuver, which they didn’t have before and many countries around the world do not have at all. “.
    Argentina already defaulted 75% of its debt… So is not a low debt obligation, it is a country that did not pay its obligations in the past. Reasons could be discussed, but is a fact..
    Real reserves of the Central Bank are something also to be discussed, the accountability of these reserves is tricky.
    Interesting discussions… I recommend to make it even more attractive to invite older Argentinean economists or not, people who already lived many crisis in this country, where crisis are the regular situation and stability the weird times..

    • Thanks Agustin

      Due to time my last few posts have been a little superficial.

      Next week’s posts will be more technical and I believe will appeal more to Argentines who have lived through crisis and are currently navigating the current situation.

      Thanks for reading and commenting 😀

    • Laura says:

      Hi Agustin,

      Germany also did not pay it’d debt obligations after world war 2 and it’s considered the biggest default in modern history. But, no one still says Germany has a high debt obligation. Instead germany now serves as an example of fiscal responsibility. This happened because There was a consensus in the international community to forgive its debt, after the fAiled reparations experiment of ww1.

      Argentina was able to get 92% of the bond holders that held its debt, to agree to take a 75% haircut. By renegotiating, they were able to create a new contract. So, technically and in reality they now have a low debt obligation.

      I agree that CB reserves are tricky to estimate, but they wouldn’t be published in the economist if they werent somewhat reliable, also considering that now they refuse to Include the INDEC inflation numbers.

      Your suggestion to add argentine economists into the discussion would be great. A good list would be, Miguel kiguel, Machinea from The de la rua government, Daniel borenstein who influenced the creation of the inflation linkedargentinebond,and maybe generating a thread between those new economists that are being put in the government that have had most of their training from la UBA, generally known as a left wing university and the economists that have been trained in ditella,ucema and San andres. Or more orthodox training

  7. Hunter says:

    Appreciate the very thoughtful discussion by all. I lived in Argentina from 06-08, and still have a number of good friends I keep up with, so I’m always interested in where Argentina is headed.

    I don’t have much technical econ commentary to add, but wanted to back off a bit from in the weeds and suggest that Argentina’s biggest economic problem is its politics. I think this has been referenced, but wanted to focus a bit more on the influence the destructive political cycles have on the Argentine economy and its people.

    I actually think Argentine politics is too fragmented, and could use some mergers to benefit the larger country. (everyone is a Peronist, but then there are many splits within the party. and then there are other parties). It is a joke that CFK refers to the country as a democracy (or any other politician). It is a corrupt oligarchy with the owners being the labor union bosses and political party leaders.

    Political parties essentially act as mafias, so when one is in power, it is very short term thinking in gaining more power, control and influence over as many resources as possible. If there was more consolidation among political parties, perhaps there would be more unification on long term vision setting (having 2 or 3 competing long term visions vs. 7 or 8 seems more helpful).

    Economically speaking, I think Laura is correct in that the sitting government would need to challenge labor unions on pay increases to bring down inflation (and she’s right, CFK will never do it). I think bringing down inflation is the most important thing Argentina could do economically at this point in time. If higher rates are necessary to do this, I think that’s ok, as access to affordable credit in Argentina is already ridiculous to come by for small and medium size businesses (so the threat of higher rates cutting off credit I don’t think is a threat, since it’s already present).

    Long term, the country will benefit most from a lower inflation rate.

    While there may be a surge in “unemployment,” I think for Argentina that’s also ok, as many work “en negro.” The Argentine people are a very creative and intelligent bunch of survivors, and will get through all sorts of things, in spite of what their coward political leaders throw at them day to day.

  8. hs1707 says:

    Appreciate the very thoughtful discussion by all. I lived in Argentina from 06-08, and still have a number of good friends I keep up with, so I\’m always interested in where Argentina is headed.

    I don\’t have much technical econ commentary to add, but wanted to back off a bit from in the weeds and suggest that Argentina\’s biggest economic problem is its politics. I think this has been referenced, but wanted to focus a bit more on the influence the destructive political cycles have on the Argentine economy and its people.

    I actually think Argentine politics is too fragmented, and could use some mergers to benefit the larger country. (everyone is a Peronist, but then there are many splits within the party. and then there are other parties). It is a joke that CFK refers to the country as a democracy (or any other politician). It is a corrupt oligarchy with the owners being the labor union bosses and political party leaders.

    Political parties essentially act as mafias, so when one is in power, it is very short term thinking in gaining more power, control and influence over as many resources as possible. If there was more consolidation among political parties, perhaps there would be more unification on long term vision setting (having 2 or 3 competing long term visions vs. 7 or 8 seems more helpful).

    Economically speaking, I think Laura is correct in that the sitting government would need to challenge labor unions on pay increases to bring down inflation (and she\’s right, CFK will never do it). I think bringing down inflation is the most important thing Argentina could do economically at this point in time. If higher rates are necessary to do this, I think that\’s ok, as access to affordable credit in Argentina is already ridiculous to come by for small and medium size businesses (so the threat of higher rates cutting off credit I don\’t think is a threat, since it\’s already present).

    Long term, the country will benefit most from a lower inflation rate.

    While there may be a surge in \”unemployment,\” I think for Argentina that\’s also ok, as many work \”en negro.\” The Argentine people are a very creative and intelligent bunch of survivors, and will get through all sorts of things, in spite of what their coward political leaders throw at them day to day.

    • Very good comment Hunter – Its nice to have another long term expat in the discussion. What is your response to the fact that these “coward political leaders” are indeed democratically elected and don’t really face any legitimate opposition from a better challenger?

      Aren’t the Argentines also responsible for their own government?

      • Hunter says:

        Que se vayan todos!

        Would be my reply, while turning to the futbol game on tv to sip some more mate and eat an empanada…(I actually wouldn’t do that, but I know many Argentines would).

        Yes, the Argentines are responsible for those they elect, but I would put an asterisk next to every election because there is so much corruption with each one with respect to vote buying and influence that I have a hard time believing they are fair democratic elections. Even if things happen that are permitted by Argentine law, I would still label them as corrupt.

        Buying electrodometicos for families right before election time or heavy social subsidies throughout the year where when payments go out, they make it clear who to thank…the sitting party sees it as a small investment they have to make to be able to steal from the kitty the rest of the time. (Many Argentine citizens are short term thinkers in my opinion as well as their political leaders and fall subject to the money influence trap too often)

        Many everyday Argentine citizens feel hopeless at this point with regards to their politics, and feel like nothing will ever change. I think many are reluctant to pursue some sort of armed resistance if it ever got to that with the memory of the Military Junta still lingering on many’s minds. They like to yell, bang pots in the street, go on union strikes, go to their shrink, but because this type of reaction has gone on for so long in the country, it seems now to have no society changing effect (it’s just normal).

        For a more practical way forward, I think creating stand alone (apart from govt) institutions that are privately funded are needed to train future political and economic leaders. This means apart from public universities, such as UBA, who would potentially be subject to influence over funding. Or perhaps something abroad – something akin to the Chicago Boys from Chile. They don’t need to be trained in the US necessarily, but it would be helpful if an intellectual group of Argentines got out from under their own pile of dysfunction and saw how institutions can work effectively in other places around the world.

        But again, I don’t know if this would ever happen, because many wealthy Argentines don’t have a large philanthropic culture. If I win the lottery, which I rarely play because the odds are so terrible, I will devote a large chunk of change towards this idea.

  9. Pingback: American Overkill » Argentina: Shrinking

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