For the first time since taking office, President Mauricio Macri is at a complete loss as to what to do. After having sold his soul to the devil — asking the International Monetary Fund (IMF) for an emergency loan — and even tolerating a legislative defeat of his position regarding legal abortion (Macri’s personally against it), the president was forced to fire Central Bank chief Federico Sturzenegger, whose monetary policy has proven absolutely ineffective at taming inflation as Argentina’s spiralling currency crisis grows by the second.
Many had called for the controversial Sturzenegger’s head, including the Machiavellian Cabinet Chief, Marcos Peña, yet the former central banker always counted on the president’s support, until last week at least. And, as Sturzenegger signed the country’s letter of intent to the IMF covering the fine details of the goernment’s economic plan — including further Central Bank independence — he was asked to quickly hand in his resignation. In his place we’ll now see Luis “Toto” Caputo, the former finance wunderkind tasked with taming the market. Caputo, a Wall Street trader, cut his teeth raising billions of dollars that Macri’s government needed badly. Beyond the paradox of promising the IMF an independent central bank and immediately replacing its chief with a man that couldn’t be closer to the Casa Rosada, Caputo will now face the inherently conflicting tasks of regaining control of the Argentine peso, putting a roof on inflation and avoiding a recession. After 30 months of failed monetarism, Caputo’s trading chops will be put to the test as a lastditch effort by Macri and Peña to finally put Argentina on a sustainable economic path before falling prey to the ungovernability that a recession coupled with a bloodthirsty peronismo can bring about.
Sturzenegger was a prized, and elusive, prey. His neck had been on the chopping block at least since last December, when an emboldened Peña forced a public humiliation of the then-Central Bank chief. Emboldened after a solid electoral showdown with Cristina Fernández de Kirchner in midterm elections, Peña and his acolytes weren’t happy with the meagre pace of economic growth, and found blame in Sturzenegger’s incredibly high interest rates, forcing the Central Bank to increase its inflation targets for 2018 (well above the 15 percent projected in the official budget approved by Congress just one day before) and lower rates. It’s surprising he lasted this long, as the past six months — since the fateful December 28 press conference — have been a rollercoaster ride that saw the peso spiral out of control as higher inflationary expectations were matched by rising prices across the board. The Central Bank lowered and then raised rates, intervened currency markets ineffectively, losing some US$10 billion in foreign reserves while the peso slumped to record lows, and effectively lost all sort of connection with the market. After more than a decade alongside Macri, he was hung out and left to dry. Good riddance, Macri’s closest advisers probably thought.
Chronicle of a death foretold. In retrospect, it’s clear that Sturzenegger’s monetarism was failing, particularly as exogenous conditions turned against Argentina — namely, the Federal Reserve’s rising rates which generated a run on fragile emerging market currencies, and a draught that hit crop yields and therefore exports. But that’s an incomplete and weak explanation.
Sturzenegger sought to professionalise the Central Bank following in the lead of former Fed chairman Ben Bernanke. He tried to use communication (including inflation targeting) and interest rates to lower inflation. At the same time, he attempted to control the monetary base by sterilising excess pesos coming into the system as a consequence of foreign debt sales. It worked like this: Caputo, at the Finance Ministry, borrowed in dollars, which in turn were bought by the Central Bank, printing pesos which were used by the Casa Rosada to finance the deficit. Sturzenegger would stash the dollars to build his foreign reserves, and sell short-term paper —known as Lebacs — with very juicy yields in order to make them attractive to investors.
Thus, he created a ticking time-bomb. The stock of Lebacs snowballed into 1.4 trillion pesos, which need to be rolled over in the short-term and paid some 40-percent interest. This attracted speculative investment, both domestic and international, which generated peso demand and kept the Argentine currency artificially strong. This incentivises imports and spending overseas, feeding the worst trade deficit in Argentina’s history, while agro-exporters sit on their crops, betting on a stronger dollar in order to sell their goods, which would then fill the government’s coffers with much needed hard currency. Since late-2017, capital flows out of risky assets and into the dollar have caused extreme volatility in Argentine currency markets, which translates into painful devaluations, which in turn are passed on to prices, feeding inflation.
Since December 1, 2017, the devaluation of the peso amounts to 63 percent while inflation over the past 12 months to May stood at 26.3 percent, meaning it is accelerating once again. Interest rates, stuck at 40 percent, have a recessionary impact on businesses by raising the cost of money, while incentivising investments in Lebacs rather than in the real economy. Higher inflation erodes purchasing power, as real wages fall, which in an economy that is absolutely dependent on consumption — it makes up 86.9 percent of GDP — generates recessionary conditions. Add the government’s austerity programmes which will slash subsidies thus increasing living costs and you have the perfect recipe for stagflation and recession.
Enter Caputo. A former portfolio manager for JP Morgan and Deutsche Bank, Caputo is by all means a market expert. As investigations in Perfil exploring the Paradise Papers revealed, he even ran a hedge fund in a tax haven that invested in Argentine sovereign debt just before joining the government. An economist by training, Caputo will now have to feed the beasts — his former colleagues. Hungry for returns, market participants will test Caputo’s resolve by selling pesos en masse. Its unclear what the impact of stabilising a free-flowing peso — a condition set by the IMF — will have on inflation in the medium-term, but at least it won’t eat at his reserves as the dollars will come straight from Treasury. Caputo will also try to dismantle the Lebac-bomb by purchasing those from investors, while the Treasury, now controlled by Dujovne’s Economy Ministry, will sell longer-dated paper in an attempt to sterilise pesos. They will be hoping for willing investors in peso-denominated assets. A hard sell these days. And say goodbye to Central Bank independence, given Caputo’s personal proximity with Macri. Hope you can handle that, Christine Lagarde.
Things have gotten real for Macri. His approval ratings plummeted, the economy is in full stagflation, and his favourite economist is being figuratively butchered in the Plaza de Mayo. Peronists are growing bolder while union leaders — fearful of landing in prison — are gaining momentum in their negotiations. Caputo better solve this quick. Or else even Lionel Messi with the World Cup Trophy won’t be enough to keep Macri in the Casa Rosada.