On Sunday, March 4, Argentina’s President De la Rua named Ricardo López Murphy as his new finance minister. This was a significant move, duly rewarded by an 8% surge in Argentina’s stock market. Could he trigger a recovery after several lackluster years for the market?
For the past couple of years, Argentina has been investors’ favorite Latin American whipping boy. Every time a problem came up in world markets, rumors would emerge that Argentina would devalue its peso. Recently, when Turkey devalued its floating currency, those rumors returned. But comparisons between Turkey and Argentina are baseless. In my opinion, Argentina has no financial problems that would force devaluation. For a decade, its peso has been 100% backed by U.S. dollars held in its currency board system. Unlike most countries, in which currencies are backed by the full faith and credit of their countries via central banks, the Argentine Peso is backed by a one-for-one holding of U.S. dollar reserves.
The financial press is often confused by Argentina’s currency situation. In inflammatory articles, journalists often refer to the peso as being “pegged” to the dollar, and treating it as if the government were intervening in markets and spending money to hold up the currency. Because the peso is fixed to the dollar, however, rather than pegged, so every peso created has been in effect “pre-secured” by a U.S. dollar added to reserves. This means the government doesn’t need to spend money to uphold dollar-peso parity.
Devaluation of Argentina’s peso would have to result from a political decision, but only the most economically illiterate politician could imagine that choosing to devalue the currency would benefit the country. The whole of Argentina has issued about $150 billion of debt to foreigners, most of it dollar-denominated. A devaluation of the peso would simply make all of that debt even more difficult to pay back, and create a situation similar to but even more catastrophic than was seen in Thailand in 1998.
The reason economic weakness often leads to currency devaluation is that for most governments, the majority of their debt is domestic in nature, and denominated in their own currency. So devaluing a currency is seen as a way of avoiding a full repayment of debts, in effect reducing the debt burden. In Argentina’s case, with most debt denominated in US dollars, a devaluation of the peso would actually increase the debt burden and make repayment more difficult.
For sharp investors, the question is not “will Argentina devalue?” it is “will Argentina require debt restructuring?” The appointment of Ricardo Lopez Murphy suggests that the answer will be “No!” Lopez Murphy seems to recognize that the main problem in Argentina is the government’s inability to control and reduce government spending. Heavy spending required heavy borrowing, and last year Argentina finally reached the point where rates were nothing less than punitive.
The former finance minister, José Machinea, made some mistakes – he essentially said all the standard things required to get assistance from the IMF. Worse, he administered tax hikes amidst a recession. He never gained investors’ full confidence, perhaps because he also presided over Argentina’ s central bank back in the late 1980’s when annual inflation was over 100%.
Ricardo Lopez Murphy, on the other hand, seems more willing to fight for his economic ideals. He’s frequently described as a stern, “orthodox” economist, but considering the sad state of current economic orthodoxy, he’s much better than that. He gained his Master’s degree in economics from the University of Chicago, absorbing ideas from free-market thinkers like Milton Freidman. He’s been head of Argentina’s most prestigious economic think-tank. He’s even been enough of an anti-politician to have publicly suggested years ago that all government employees should receive a pay cut.
The rise in Argentina’s stock market seems to anticipate three positive policy goals from Lopez Murphy, which can be summarized in six words: sound currency, reduced spending, reduced taxes. Most immediately, he forcefully reiterated Argentina’s commitment to the fixed U.S.$ currency board system, reducing political-based currency risk. His highest priority is expected to be cutting government spending, the root cause of Argentina’s economic problems. At present, he is working on a budget package that many believe will include at least $4 billion in spending cuts. His final priority is expected to be tax reduction and simplification, in order to reduce obstacles to economic growth. Rumors are that he may reverse last year’s $2 billion dollar personal income tax hike, and reduce the 21% national sales tax rate while eliminating a number of exemptions.
Ricardo Lopez Murphy’s appointment holds much promise for the Argentine economy. We’ll see whether his policy specifics live up to this promise, and whether he can push these plans past Argentina’s notoriously spendthrift congress. So far, investors appear to be reversing past pessimism and driving up stocks. (See http://www.mscidata.com/mstool/mschart.wsx?AR for a chart of the Argentine stock market)