Javier Milei shocked the political establishment when he romped to victory in the Argentine Presidential election in 2023. A proud anarcho-capitalist, he took advantage of the disastrous track record of the incumbent left-wing administration, but took over a country experiencing an economic trauma. In his mission to rescue the economy, few things are as essential as fixing the exchange rate regime.
Argentina has a chequered economic and political history. In the 1880s the country introduced liberal economic reform and eased immigration policies. This became the basis for decades of strong economic growth, and in 1908, Argentina enjoyed the 7th highest GDP per capita in the world. The Great Depression hit hard and after the 2nd World War, the country turned left with the election of Juan Peron, who was ousted in a right wing military coup a decade later. He returned to power in 1973, but died a year later and was succeeded by his wife, Isabel. Another military coup ended democracy in 1976 but the junta fell in 1983 after the Falklands War dealt the economy a new blow. 1992 saw the replacement of the Austral with a new currency, the Peso, which was pegged to the US Dollar, but it failed to stabilise the economy. In 2001, the Peronists took control of congress and in 2003, Nestor Kirchner ascended to the Presidency, to be succeeded by his wife Christina Fernandes Kirchner in 2007. Except for a 4 year reign by conservative Mauricio Marci, the Peronists held on to power until Milei’s shock victory.
Government deficits, economic decline and devaluation of other South American currencies made the Peso’s peg to the US Dollar difficult to maintain. In 2002, the fixed exchange rate system collapsed and the Peso was allowed to float. It rapidly lost 70% of its value. The government imposed strict currency controls and forced conversion of foreign currency holding at an exchange rate of 1:1, imposing large losses on the private sector. The controls also forced exporters to convert foreign currency earnings to Peso at the official exchange rate. The consequences were an increase in poverty, devastation of the middle class, high inflation and a loss of faith in the banking system. The regime has resulted in several parallel exchange rates: the official rate, mandated for things like government transactions and export and import business, co-exists with a black market where the Peso trades at lower prices, reflecting more accurately actual supply/demand dynamics.
The devaluation did make the economy more competitive but the decades since have seen a volatile economic performance, not least due to Argentina’s exposure to commodity prices (mainly soy beans and other agricultural products). But during good times and bad, the Peronist rule saw large scale government deficits to fund an ever expanding public sector. To cover the shortfall, the government relied on money printing, both in the form of loans from the central bank and QE style arrangements where the central bank purchased government debt securities. Despite these tricks, official government debt to GDP rose steadily, reaching more than 100% in 2022. Inflation turned to hyperinflation, reaching more than 150% in 2023.
Javier Milei entered office in December 2023 faced with this messy and disastrous legacy, warning voters that things would get worse before they get better. No task is more complex and crucial than normalising the currency regime. Currency controls are seen as a major impediment to attracting foreign investment into the economy (foreign companies don’t want to be stuck holding devaluing Pesos). To address the unsustainable discrepancy between the official and black market exchange rates, Milei immediately devalued the Peso from ARS 400 to ARS 800 per USD. This inevitably hit the economy hard. Inflation reached almost 300%. With much of the government debt denominated in USD, debt to GDP immediately shot up to 150%. Following the initial adjustment, a policy of gradual depreciation was introduced, allowing the Peso to fall by a monthly rate of 2%, adjusting to 1% from January 2025. Currency controls are being eased, but restrictions remain on the amount of US Dollars citizens and companies can buy. Argentina suffers from a chronic shortage of US Dollar. The economy relies heavily on imports and faces debt repayments in USD and with the central bank struggling to maintain adequate currency reserves, there’s a fear that abolishing currency controls could lead to capital flight, leaving the central bank unable to manage the exchange rate. The aim is to bring the official Peso rate in line with the black market rate, allowing all controls to be lifted by the end of 2025. The expectation is that without multiple exchange rates, the Peso will stabilise. A cheaper currency will also improve the trade balance. This should ease the demand for US Dollars (exporters sell more and earn more USD and importers face higher price and demand less USD) and allow the central bank to increase its foreign currency reserves. Concerns remain for a run on the currency when Argentines regain the freedom to sell their Pesos. Hence, the government is keen to secure an IMF loan to shore up reserves. But challenges remain. Though a stable exchange rate will help reduce inflation, the devaluation of the Peso leaves Argentines poorer, compounding the effects of the austerity programme introduced to deal with out of control government spending. The government has cut over 33,000 jobs, reduced subsidies and cut social programmes and despite putting an end to the money printing shenanigans that flattered budgets in the past, recently posted its first budget surplus in more than a decade. A balanced budget will help stabilise the money supply and reduce inflation further, in turn decreasing pressure on the Peso.
After decades of socialist mismanagement, Argentina has an opportunity to escape the economic death loop that threatened to engulf the country. Early signs are promising. After the initial chock of devaluation, inflation has dropped from 166% before Milei took power to 118%, the economy emerged from recession in the third quarter of 2024, unemployment is falling, real wages are increasing and the poverty rate is retracing after spiking as Milei’s shock therapy took effect.
But the massive economic transformation that is needed takes time. With Milei still having 3 years left of his current term and enjoying up to 65% approval ratings, a good result in October’s legislative elections could provide some political stability and an opportunity to push through the necessary reforms. If he succeeds, Milei will have pulled off a stunt only fringe libertarian economists thought possible and created a blueprint of successful economic management that should inspire voters and governments the world over.