Inflation Crushing Argentine Currency

Europe is bogged down in what looks more and more like a permanent state of industrial poverty. I have likened their future to what South America became during the 20th century: a cluster of countries with their good days of prosperity behind them.

This is not entirely a fair comparison, since both Brazil and Chile have made great strides toward rising above the industrial poverty that otherwise holds the continent in a tight grip. But as a general rule, it is entirely reasonable. Just like South America lost its course in the mid-20th century, Europe is going down in the early 21st century.

Europe’s only chance is to totally dismantle their welfare states and start over on free-market terms. I do not see that happening, just as it has not happened in countries like Venezuela and Argentina. (Chile is a different story.) Especially the Argentine example is useful as a general forecast reference for Europe: they have done everything they can to keep their welfare state in place, with the inevitable result that there is not enough tax revenues to pay for all the entitlements.

As a desperate measure to continue the welfare state despite inadequate tax revenues, the Argentine government has turned to money printing. As I reported in September last year, this is causing runaway inflation. For 2012 the inflation rate reached 30 percent, a downright destructive level.

The Argentine government has had plenty of time to see the writing on the wall – the country’s credit rating was downgraded in November last year – but chose not to. Instead, inflation is now destroying their currency and people are hoarding dollars as a last-resort measure to survive. Bloomberg Business reports:

A lot of U.S. dollars are tucked away somewhere in Argentina, most likely in stacks of $100 bills. Seven years ago, the U.S. Treasury, working with the Federal Reserve and the Secret Service, estimated that in the early 1990s Argentines held $20 billion in cash, a number that by 2006 had grown to “perhaps $50 billion or more.” That year there was a total of about $768 billion worth of dollar-denominated cash in the world, which means that someone in Argentina held at least one out of every 15 cash dollars.

This is an interesting number. Anecdotes out of Europe from the first few years of the euro alleged that assorted mafia organizations were dumping the dollar and going for the euro instead. Its highest denomination is 500 compared to the 100 maximum denomination of the dollar. Since the two currencies are largely equally valued, it made a lot more sense for those in more illicit businesses to carry euros. This would have released lost of high-denomination dollar cash, which could then be unloaded in perennially dollarized Argentina.

Back to Bloomberg:

Demand for large dollar cash transfers to Argentina since 2006 … has outstripped demand for dollar cash overall in the world. So it seems safe to say that today Argentines hold probably well more than $50 billion, and well more than one in every 15 dollars. (This is why the government of Cristina Kirchner is so furiously digging at the country’s undeclared wealth. Not to bring home what Argentines hold abroad, but to uncover some of those dollars Argentines have—literally—at home.)

She has two reasons for doing this. First, the dollar holdings are likely the result of financial activities not reported to the tax collectors. With a deficit equal to $14 billion, the Argentine president’s mouth is watered by the prospect of taxing undeclared dollar holdings:  if the government could seize 28 percent of those holdings, it would be enough to eliminate the budget deficit

In one year. The following year, of course, the deficit would be back again. And since you can only confiscate the same dollar once, this would be a stupid solution to a stupid problem.

The second reason for President Kirchner to want to seize dollar holdings from Argentine families is that the country’s own currency is plunging almost as fast as Obama’s presidential credibility. By confiscating people’s dollar holdings she could try to force them into increasing demand for the Argentine dollar. Zerohedge has an interesting illustration of how the Argentine currency has lost value vs. the U.S. dollar on the informal currency market: a year ago the formal and the informal exchange rates were within striking distance of one another; today the informal market pays twice as much for a U.S. dollar than the official exchange rate does.

This is a scathing free-market verdict over the Argentine currency, but indirectly also an acknowledgement by rational economic men that their government is on a fast track to destroying their economy. By hoarding dollars they stand a fighting chance to survive when their domestic currency collapses.

It is worth noting that currency collapses tend to happen in countries with big, entitlement-loaded welfare states. We need not look farther than what is happening in Europe, where the European Central Bank has made a promise to print an unlimited amount of euros to pay for the debts of the euro zone’s welfare states. As a result of this, the general opinion among financial investors and analysts has now shifted away from assessing the strength of the euro to forecasting its demise.

There is really only one reason for a central bank to run amok with its printing presses, and that is to finance a government deficit. That deficit, in turn, is almost always the result of a runaway welfare state. Therefore, the safest way to a sound currency and restraint in money supply is to eliminate the welfare state.

Europe needs to learn this. They have already started on the reckless path to excessive money printing. Thus far it has not come to the point where it causes inflation – the extra cash has not yet reached the transmission mechanisms between the monetary and real sectors of the economy. But when it does, Europe will rapidly ratchet down the South American slope.

2 comments

  1. anti-sharia

    Great article and I agree entirely with the link betw money printing and socialsim (welfare).

    However your final statement is off by a long shot! We have significant Euro-zone inflation. What’s the cost of 10 tomatoes vs 10 years’ ago, double up. A box of cornflakes, double up. A kg of filet meat…and so on. I say its 5-8pc annually.

    But worse: what would have been the price of oil (fuel) after the crash of ’08…? I’d say $50 oil is a fair guess. So $90 Texas shows you that ‘stabile prices’ might indeed camouflage huge price increases, ie money bazooka took away a much welcome deflationary effect of the ’08 crash. Instead, prices kept up as more money chased same/less goods.

    Anti-sharia

    • S R Larson

      It is always telling to present individual goods in the way you do, because it puts some meat (no pun intended) on the story. You also allude to the fact that some people have a different consumption basket than others. I agree with all this. However, you are under-estimating the economists and statisticians who keep track of prices. Price indexing is a refined science, and its most commonly used inflation rate for the euro zone shows that the 17 euro-area countries have averaged 1.6-2.7 percent inflation since 2010. The higher end of that would be a bit out of the ordinary given the poor GDP performance, but there have been a lot of tax increases over the past few years in the euro zone, which in turn has driven inflation a notch higher than it otherwise would be.

      It is not until inflation closes in on five percent that the monetary part takes charge. The euro zone is not there yet, but that does not mean they can’t get there. Your comment provides a narrative that points in the same direction.