Milei's Psycho Shock Therapy

Javier Milei was elected president of Argentina last November, and was inaugurated later in December, facing an ongoing and long-standing economic crisis that Milei claims was caused by the Peronist “socialist” agenda. The deep and persistent crisis explains, to some extent, how Milei, perceived by many as an outsider, rose to power. The truth is that Milei is part of a typical cycle in Argentine society that Marcelo Diamand, a key Argentine intellectual, refers to as “the Argentine pendulum,” wherein populist governments more concerned with growth and redistribution reached promote these policies until they reach the limits of the economy, external deficits, depreciation and inflation acceleration ensued, and a right of center government promoting adjustment followed. Milei is the last iteration of that process.

The actual roots of the crisis lie in the country’s external debt in foreign currency, which is the result of several decades of neoliberal policies. The cycle started with the first neoliberal experiment during the last dictatorship in the 1970s, which led to the debt crisis and two bouts of hyperinflation in the 1980s. The neoliberal experiment under President Carlos Menem in the 1990s managed to stabilize the economy, with the help of the Brady Plan, a program for reducing the payments and the interest on external debt sponsored by the United States, but led to a huge crisis in 2001 and a default on external debt in 2002. Argentina recovered and thrived after that with the left-of-center governments of Néstor and Cristina Kirchner. The 2002 default was resolved in two hard renegotiations with international creditors, including the International Monetary Fund (IMF), in 2005 and 2010, and finally sorted out with the vulture funds, that bought Argentine debt for pennies on the dollar and sued in American courts to obtain full payment. The payment to the vulture funds was made by the neoliberal government of President Mauricio Macri in 2016, in very unfavorable conditions. However, the external debt problem persisted as a source of macroeconomic instability, since during the Macri administration the debt in foreign currency more than doubled, and the central bank, which was already low on international reserves, did not accumulate significant amounts of dollars. Capital came in, and capital went out. The reasons that allowed the Macri government to attract capital were higher interest rates, at least for a while, and the final resolution of the previous debt crisis with the payments to the vultures. By 2018, the government went to the IMF for fresh money, and by 2019 the economy was almost in default. The government of President Alberto Fernández never managed to get a grip on the crisis, and the Covid-19 pandemic exacerbated existing macroeconomic instabilities and political discontent. The election of President Javier Milei, the most recent neoliberal experiment in Argentina, is the result of the inability of previous administrations to tackle the country’s problems head on.

The Last Swing of the Pendulum

All the previous neoliberal administrations exacerbated the country’s external debt problems, and the subsequent, more progressive governments have been unable to find a solution to the crisis. President Milei’s economic measures are certain to create further problems. For the most part, his administration’s economic measures are what’s typically expected from neoliberal governments. The only new aspect of President Milei’s flavor of neoliberalism are his histrionic tantrums and his eccentricity, both of which surpass those of former President Menem, and are the reason he is referred to as El Loco (the crazy one). But there is a method in the madness of the Argentine right. They create unsolvable crises, and tie the hands of the subsequent governments, creating the conditions for their return, and for the Argentine pendulum that favors their interests.

Since 2011 the economy has stagnated, with average growth of about 0.5% of GDP per year. By the time President Cristina Kirchner’s administration ended in 2015, the country’s inflation rate was about 25%, which was higher than in most countries in the world. During President Macri’s administration, the inflation rate accelerated to more than 50%, and when inflation increased around the globe during the pandemic, Argentine inflation quickly accelerated to three digits, to around 180% by the end of Fernández government in 2023. The reasons for both the recession and the acceleration of inflation are to be found in the external problems of the country, mainly the large external debt, the trade deficits, and the lack of international reserves that would allow to pay the debt in dollars. Despite the efforts of recent progressive administrations, including the Kirchners and that of Fernández, in which Cristina Kirchner was the vice president, these problems still remain.

After the 2002 default, the country run trade surpluses, in part as a result of the boom in commodity prices, but once the economy reached the limit of the current account in 2011, and trade deficits became the norm, the lack of dollars made growth impossible. Growth requires imports, and those require dollars. To economize on the use of dollars, and preclude that the few dollars were hoarded, Cristina Kirshner imposed capital controls, trying to made it hard for people to buy dollars. When dollars are scarce, and they are in high demand, the exchange rate tends to depreciate, in other words the peso loses value. If there are restrictions to the purchase of foreign currency, a parallel market will develop, with a premium on the price of dollars. If interest rates remain low and below the expected depreciation of the peso, as they did for most of the time in the case of Argentina, this would lead to capital flight. Further, there would be an increasing tendency for the economy to become dollarized, since under these conditions it is always more advantageous to hold dollars than interest-bearing assets in pesos, since the pesos depreciate faster in dollars than the interest that could be obtained in peso denominated bonds. The depreciation of the currency led to higher prices for imports, which together with wage resistance, fueled inflation. President Macri lifted capital controls at the beginning of his term in 2015, but when the external situation worsened, he reimposed them, and obtained a huge loan from the IMF, which limited what President Fernández could do when he was elected in 2019. Macri essentially left the country in default, and Fernández’s administration was unable to get the country back on track.

Soon after he took office, President Milei chose Luis Caputo as his finance minister (Caputo held the same position under Macri). President Milei’s close advisors include Federico Sturzenegger, now minister of deregulation, who was the president of the central bank in the previous neoliberal administration. Since taking office, President Milei depreciated the official exchange rate by more than 100%, to reduce the parallel market premium, and implemented a draconian fiscal adjustment, reducing cutting spending on pensions, education, particularly for the public universities, for the health program and other social programs, that he claims has led to a balanced budget. In reality, this adjustment is a bit of a sham, an accounting gimmick. For example, the distributor of electricity, Edenor, which was privatized in the 1990s, has stopped payments to electricity producers, and the government is negotiating the bill, which will not be zero, even though that is what they show on their balance sheets. Many other cuts are unsustainable, since, for example, energy producers will have to be paid for them to continue to operate, and the cuts on the pensions of the retired cannot go beyond a certain limit without leading to deaths. In fact, deaths associated to the cut of cancer treatments have been documented. Even the IMF has suggested that the measures have gone too far and might have severe social consequences. Note that fiscal adjustment and depreciation are the traditional IMF policy prescriptions for countries in default.

Stagflation and poverty

As a result of Milei’s measures, inflation accelerated to more than 25% in December 2023 right after and as a result of the exchange rate depreciation, and as the depreciation moderated, inflation has decelerated. Some commentators believe the reduction in inflation results from Milei’s program and that this has been, to some degree a success. However, it is worth noticing that inflation is more or less at the same level as before the global acceleration of inflation before the pandemic (Figure 1), and remains at three digits on an annual basis. However, the acceleration of inflation resulted directly from Milei’s actions, the depreciation of the peso, that increased the price of imported goods and was passed to domestic prices, and the reduction has been directly associated to the intervention in the foreign exchange market to preclude the further depreciation of the peso. Milei had campaigned on eliminating the foreign exchange controls, and allowing markets to determine the exchange rate, but he has used the scant reserves of the central bank to buy pesos and keep it from further devaluations, something that he criticized in previous administrations.

The austerity and cuts to social programs did not play any significant role in the stabilization. Only indirectly, by reducing imports, that fall with a recession, and reducing the demand for dollars for those imports, did the fiscal adjustment play a role. And the collapse of the economy has been steep, with very visible social consequences. The official numbers show a decline of GDP in the first semester of about 5.1%, in a global context of recovery from the pandemic, and with inflation also falling. The IMF, which more often than not underestimates the effects of fiscal adjustments, predicts a recession of about 2.5% of GDP. The real numbers might be much worse.

Figure 1 Monthly Consumer Price Index (CPI)

Source: INDEC

Milei’s bet is that a more friendly investment environment, which is part of the mega-package that he was able to pass through congress, will bring foreign investment, and attract enough dollars for him to eliminate the capital controls and perhaps even formally dollarize the economy, meaning adopt the dollar as the official currency, something done in a few countries like Ecuador and Panama, with dire consequences. Dollarized countries, that lack their own currency, must by definition borrow in foreign currency, and their ability to service their debt, which is always in dollars, is dependent on exports and the whims of international markets. The evidence suggests that they grow less than the global average.

An investment boom based purely on the confidence of international markets is unlikely. But there is a scenario in which Milei’s plans for stabilization may work. If the recession is large enough, contracting imports, while exports grow at a more normal rate or even accelerate with an increase on exports of commodities like lithium, of which Argentina has large reserves, then he obtains a few more dollars, and with exchange rate stability he might be able to bring inflation down. This could be facilitated by a reduction of the payments to the IMF, and more so if Milei and Caputo can negotiate some additional credit, which is not completely out of the question. The social cost would be enormous, and there would be a possibility of a social revolt. In fact, in his short tenure, the poverty index has increased by 11.2%. However, he might survive it, perhaps increasing the level of social repression, something he has already shown is capable and willing to do. If that were the case, when the Argentine pendulum swung back to the left, as it will inevitably at some point, then the next government would have its hands tied by dollarization. For Milei, and the Argentine elites that do benefit from his policies, this would be a complete victory.