Commentary: Argentina's Crisis Explained

Argentina again finds itself at the mercy of the financial markets. The story this time, however, is one of politics as much as economics. A brief overview of recent Argentine political and economic history is necessary to understand my analysis. 

In 2015, Argentina's neo-Peronist government failed to win re-election. Inflation was already very high and the government was falsifying inflation statistics. The Peso was pegged to the dollar around 14-1 and the government kept a tight grip on the foreign exchange market. 

When Macri's Cambiemos (lit. "Let's Change.") came to power, the situation was already very dire. One of his first acts was to float the Peso. While this was the correct move, Argentina's current account deficit actually widened. This was largely because of big portfolio inflows into Argentine assets. Markets, as they frequently do when new governments come to office, went through a temporary love affair with President Macri. The Argentine stock market was red hot between 2016 and 2018, more than tripling. In 2017, Argentina's flotation of a 100 year USD bond was a runaway success, drawing incredible demand.  

Meanwhile, inflation was running hot.  The initial depreciation from floating the Peso caused inflation to spike. However, the initial rise in the rate of inflation quickly dissipated. This at the time was a promising sign. The price increases were caused by a one-off currency shock.  With prudent monetary policy, Argentina would be able to achieve the same limited FX pass through as other economies like Mexico. 

However, as the new president's luster wore off, and the still high inflation and the sagging economy took its toll on his popularity, it became clear that the chances of a win in 2019 for Macri were bleak. Heavy inflows turned to modest outflow, while the current account gap widened further. 

Since the market is no longer interested in holding Peso denominated assets, Argentina's currency will need to depreciate even further as it continues to absorb the shock of the balance of payments adjustment. However, because inflation is largely determined by the exchange rate, it's likely that the price level will continue its rapid rise no matter what Argentina's central bank does.  High volatility will plague the Argentine asset markets until the election is settled. And currently, a Macri loss looks likely.  The only hope is that once the election is over, the exchange rate can do the heavy lifting of rebalancing the economy. Sadly, a surprise Macri win could have very perverse effects. Investors would likely plunge back into Argentine assets. This would provide some short term relief, but market sentiments can change on a dime.  Until Argentina can delink the inflation rate and the international value of the Peso, it's floating exchange rate will continue to act as an effective but incredibly painful shock absorber.