Is the Future the Past for the Peso?

By John Mouratidis– 23 March 2021

In the foreign exchange market, there is one currency with an unparalleled reputation for never-ending declines in its value: the national currency of Argentina, the Argentine Peso. It is a curious case, inextricably linked with the cratering of Argentina’s economy and the institutional political rot which plagues it. But unlike other stories of corruption and economic failure, Argentina is a fallen soldier; 100 years ago, it seemed the preeminent power of South America, with briefly the world’s highest real GDP per capita between 1895 and 1896. In 1930, a military coup ousted an elected government discredited by the Great Depression, and from there the nation’s prosperity and currency eroded with no end in sight. By delving more into what happened and why, we can try and spot that end, and learn to diagnose other currencies for the Peso’s illness.

Figure 1: 20 years of ARS/USD, with important technical trendlines shown.

The figure above, depicting the Peso (ARS) against the USD, shows the extreme devaluation. The trend is devastating, with a decline of 98% over the 20 years of data provided, and there are no obvious technical support levels to slow the decline in the near future. What we see instead is a series of descending triangles and broken support levels which seem to imply unlimited downside. Momentum indicators, such as the RSI and MACD, have been oversold for decades with no consequence, no major upside rebound. The Peso has defied gravity and therefore technical analysis, so we have to look towards a more fundamental-based explanation and projection of its value.

From 1998 to 2002, Argentina experienced a depression. It was largely a cyclical and regional downturn shared with Brazil, felt particularly heavily because of Argentina’s massive debts and reliance on exports – so extreme was the situation, that the nation defaulted on its debt in 2001 and half of Argentinians lived below the poverty line. President Nestor Kirchner was elected in 2003 and tasked with rebuilding, and in several ways he succeeded. Kirchner brought with him massive economic stimulus, increasing public spending to 25% of GDP from 14% over his tenure, using it to build 400,000 low income units and strengthen the social safety net more broadly. Unemployment was cut in half and the economy grew consistently at around 6% a year, so Kirchner clearly at least somewhat had the public’s interest in mind. But there were risks with the Kirchner approach, risks which were not fully priced into the Peso until several years into his tenure.

Figure 2: Juan Peron
Figure 3: Protests during the 1998 - 2002 depression

For one, the spending itself was not without its negative implications. While the stimulatory effect on the economy was beneficial, inflation rose to 20% which exerted downward pressure on the Peso, unintentionally making it more difficult for the nation to pay back its foreign denominated debt. The 2001 default was Argentina’s seventh in history, an unmatched track record of fiscal infidelity which has been a primary cause of capital flight for decades. Domestic and foreign investors, already unconvinced that the government would pay them back, withdrew further from the Argentine economy and the Peso as Kirchner continued to leap into indebtedness, and another default appeared increasingly likely until it happened in 2014, and again in 2020. As the graph shows, these factors really began to dominate the Peso after the global recession of 2008, when Argentina’s economic recovery began to slow down in earnest. Despite a global crisis, the Peso declined much more than its counterpart South American currencies because investors were simply less interested.

Argentina’s unique political history also differentiated the extent of the damage. Kirchner borrowed some ideas from the Peronist school, the former President Juan Peron’s philosophy espoused by many of Argentina’s leaders since he reigned in the mid-20th century. Chief among them was trade protectionism; Peron’s nationalist approach shielded the inefficient industrial sector from external competition, and Kirchner believed in a similar approach, especially detrimental given that Argentina is an export-based economy. Peron also believed in currency controls, as did Kirchner and his wife who succeeded him as President in 2007. In 2011, the ability to buy or sell foreign currency was severely limited, seemingly an attempt to curb the runaway devaluation. A gap between the official peso rate and the black market therefore emerged, shown below, and government’s reserves started to deplete as it tried to artificially inflate the currency. This particularly backfired in 2015, when the market-orientated President Macri was elected and removed the currency controls, resulting in a huge devaluation convergence with the black market rate. The resultant inflation defined Macri’s presidency, and he fell out of favour with voters when Peronism returned in 2019 through a new President Fernandez.

 

 

Figure 4: ARS black market rate in orange and official rate in blue before currency controls were lifted

 

With what appears to be such an institutional and ideological crisis, what is the solution? Well, the fundamental problem is that bad habits are ingrained in Argentine’s political culture through Peronism and other relics of its past. The government is prone to corruption, for example, and propaganda, willingly misstating inflation statistics. A centralised political structure, legitimised by Peron’s authoritarian tendencies, consists of a highly politically influenced judiciary and central bank. Drastic reforms need to be taken, and reformation of these institutions would result in more stability and less corruption – stability is urgently what Argentine currency needs to recover, having lived through multiple currency controls and removals, multiple coups, and democratic governments. With more impartial experts and restrictions involved in policymaking, spending could be better balanced in a way that ensures the safety of the welfare net and a non-overinflated economy simultaneously. More definite decisions would be made on currency controls, and a plan could be made to diversify the economy away from the Peronist relic of being purely export based. A government which proposes these reforms, if elected, would create an incentive system for good future decision making, which is what the Peso needs.

Undoubtedly other factors have contributed to the Peso’s extreme devaluation; most recently, the coronavirus has taken its toll. But it is the clear the long-term devaluation has a long-term cause: institutional mismanagement, and an uncertain approach to policy which has led investors to withdraw from Argentine assets. It is possible the Peso retraces some of its decline in the short-term, especially if it has completed its convergence with the black market rate. But until institutional change is realised, there is no reason to believe the Peso will rebound in any significant way soon.