Slip Slidin’ Away in Argentina

Last week, Argentina’s central bank finally abandoned its hopeless battle to keep the peso at an artificially high exchange rate versus the dollar. Immediately afterward, the Argentine government decided to allow more purchases of foreign currency by its citizens. But the transition from the country’s unsustainable currency regime is far from over — and it could get much worse.

The initial devaluation of the peso came on Thursday, Jan. 23, as the central bank abstained from the purchases it had long used to prop up the currency. A drop of more than 10 percent on Thursday was followed on Friday by a smaller dip, with the peso coming to rest at about 8 to the dollar. It had hit 7 pesos just two days earlier.

Just eight months ago, Cristina Fernández de Kirchner’s government had pledged not to devalue the peso. For years, it had been trying to make the central bank’s job easier by restricting Argentines’ sales of pesos in favor of foreign currencies. But as the bank’s reserves dwindled, the risks implied by creating demand for pesos continued to grow. Last week was apparently the end of the line.

A more gradual pullback might have been preferable, but it was healthy to embrace the inevitable sooner rather than later. With the currency falling to its real value in a competitive market, there would be no more need for restrictions on trading. So far, so good, then? Not quite.

The signs of a problem began in the black market for dollars. For the past several years, the black market has operated in plain sight to fill Argentines’ demand for dollars. Private traders sell dollars for many more pesos than the official rate to people who need them for travel, to invest, or simply because they think the peso will lose value in the future.

Before Thursday’s events, the main black market rate, known as the "blue" dollar, sat at about 11.8 pesos. On Monday, after some ups and downs, it settled around 11.7 pesos. To an outside observer, the gap with the official exchange rate looked smaller, which would have been a sign of progress. But from the point of view of an average Argentine, the gap had barely changed at all.

The reason was in the fine print. The government announced on Monday that households with monthly incomes of at least 7,200 pesos would be allowed to buy $2,000 at the official rate each month, more than enough for most Argentines (or at least those with the requisite income). But there was still a surcharge on many of these transactions. For purchases and withdrawals from businesses and banks abroad, the previous surcharge of 35 percent was lowered to 20 percent. Before, the surcharge resulted in an effective exchange rate of about 7 x 1.35 = 9.5 pesos to the dollar. After the change in policy, the effective rate was 8 x 1.2 = 9.6 pesos.

In this case, no news was bad news. The greater availability of dollars should have reduced the gap between the official and black market rates, but neither really changed. Why not?

Argentines may now be skeptical that, having started the peso’s slide, the government can also stop it. As the value of the peso drops, some businesses will be tempted to raise their prices more quickly. But with heightened inflation, a freely floating peso might fall faster as well. In the absence of a credible plan from the government for keeping prices in check — its existing price controls have hardly done the job — a downward spiral could ensue. To all appearances, uncertainty about prices and the peso is still generating demand for dollars in the black market.

So far, Fernández’s government has done little to combat it. Last week, Axel Kicillof, Argentina’s fourth economy minister in five years, and Jorge Capitanich, the cabinet chief, gave conflicting versions of the new rules for trading currencies, citing different surcharges for transactions (dramatized in this cartoon by Javier Rodríguez). On Monday, Jan. 27, Capitanich said the government would publish the names of every purchaser; he later reversed himself. Meanwhile, Kicillof promised to punish businesses that raised prices after the devaluation.

But to stabilize the peso, the government will have to fight inflation with more than rhetoric and threats. The process will not be easy, since inflation in Argentina is like the needle tracks on an addict’s arm — the ugly and unmistakable side effect of a long-term habit. For Fernández, the habit is spending.

During the global boom in commodities, Argentina’s central bank printed pesos to buy the foreign currency earnings of the country’s exporters. Rather than putting the resulting reserves into a sovereign wealth fund, the Fernández government used them to fund enormous increases in public sector salaries, infrastructure projects, and subsidies for energy and other essentials. These huge injections of cash into the economy did not come with equal growth in the production of goods and services, however, so inflation of more than 20 percent became commonplace.

If the government doesn’t rein in its spending, then prices will keep rising while the peso keeps slipping. This process is not always orderly, and any moment of panic can lead to hyperinflation and bank runs. But with less than two years left in her last term, Fernández may be willing to take the risk.