The Economist: Javier Milei has turned Argentina into a libertarian laboratory

photograph: alamy

Javier Milei, Argentina’s president, has enjoyed the best week of his term. At dawn on June 13th the Senate passed two bills aiming to boost growth and raise revenue, giving Mr Milei his first legislative victory since he came to power in December. Hours later he travelled to the g7 in Italy, where he giggled with Giorgia Meloni, the prime minister, embraced Pope Francis and palled around with Kristalina Georgieva, the head of the imf. “I always love our meetings,” he gushed to Ms Georgieva. Yet the relationship between Mr Milei and the fund, which has a $44bn lending programme with Argentina, may soon become less chummy. Uncertainty about the president’s plans for the central bank is worrying investors and the imf alike.

Mr Milei’s early successes are impressive given the mess he inherited. For years, the central bank had created money to finance the fiscal deficit, fuelling inflation. It also had no foreign reserves. Another default seemed almost inevitable.

In his inauguration speech Mr Milei warned Argentines of hard times, declaring that “there is no money”. He immediately fired hundreds of bureaucrats, cut spending and devalued the peso by over 50% (which initially pushed up inflation). Meanwhile, public salaries and pensions were held down, slashing their real value. As a result, Argentina has enjoyed fiscal surpluses for five months, something not seen since 2008. Inflation has fallen to 4.2% month on month, the lowest since January 2022 (see chart 1).

Some Argentines are angered by the accompanying pain. The night the Senate voted on the reforms, protesters hurled Molotov cocktails outside and set a car alight. Unions have organised huge marches. Yet despite the excruciating recession, over half of Argentines still approve of Mr Milei. Jorge Juliano, a 72-year-old taxi driver in Buenos Aires, gives a simple reason: “With the other lot we were living in Walt Disney, a fantasy.”

Investors have welcomed Mr Milei’s recent progress. But their enthusiasm is dampened by uncertainty about the president’s plans for the central bank and the peso, which is once again looking overvalued. The next few months of government may be harder than the first.

chart: the economist

One reason is political. Though Mr Milei’s coalition has just 15% of seats in the lower house, he came to office with a thumping personal mandate. This persuaded opposition lawmakers to negotiate. Mr Milei’s main bill passed with 400 fewer clauses than the original, but it is still a big win for him. It declares a state of economic emergency for one year, during which he will have extraordinary powers over energy, economic and financial matters. It also opens the way to privatise several state-owned firms and creates incentives for would-be foreign investors. The package now goes back to the lower house for final approval. It may choose to reinstate income taxes, which the government hopes for but which the Senate had refused to do.

Opposition legislators may think they have given Mr Milei enough. “It’s going to be more and more complicated,” says Luis Juez, a senator who supported the reforms. The lower house is already fighting back. It recently passed a pension formula that could cost almost 0.5% of gdp this year. Mr Milei attacked those who voted for it as “fiscal degenerates” and vowed to veto it. But if it is passed with a two-thirds majority in both houses—a distinct possibility—he will be unable to change it.

The bigger challenges, however, are macroeconomic. Mr Milei has prioritised fighting inflation, but Argentines are becoming worried about unemployment and will eventually clamour for growth. The recession has been deep. Construction activity in April was down by 37% year on year.

Complicating the recovery is the overvalued peso, which is making the country unjustifiably expensive in dollar terms. The official exchange rate is currently set by the government, which also imposes capital controls. Almost all of the devaluation in December has been eroded (see chart 2). It involved initially devaluing the peso by over 50% and then by 2% each month. But monthly inflation has been greater than the crawling peg. The result is that the real effective exchange rate is rising.

The effects are obvious from atop the Andes. On a single long weekend in April some 40,000 Argentines crossed the mountains into Chile to buy everything from trainers to car tyres because, surreally, Chile has become cheaper than Argentina. Mr Milei slams those who say the peso is overvalued as “intellectually dishonest”. Yet when an Argentine president says there won’t be a devaluation, taxi drivers know there is a good chance there will be one, quips Nicolás Gadano of Empiria Consulting in Buenos Aires.

A pricey peso scares off tourists, makes exports expensive and deters investors. An overvalued currency often eventually crashes. “If you see Argentina appreciating, this is always a sign of worse things to come,” says Eduardo Levy Yeyati of Torcuato Di Tella University in Buenos Aires. Falling exports make it harder for the central bank to accumulate dollars, which it needs to pay off foreign debts and to build up its safety buffers.

The government could allow the peso to float or accelerate the 2% crawling peg. But either would probably push up inflation, thus endangering Mr Milei’s popularity and undermining some of the benefits of the devaluation. For now, Mr Milei is able to keep a tight grip on the exchange rate because of capital controls.

Money madness

What happens next? Mr Milei has promised to ultimately remove capital controls as part of his plan to restore investor confidence. He insists that inflation will soon be 2% a month, the same as the rate of devaluation. This, he says, would allow him to slowly ease the restrictions and float the peso without its value plunging.

Eyeing the future – photograph: santiago oroz/sopa images/zuma/eyevine

This is optimistic. There is little, such as rising productivity, to justify a stronger peso. Worse for Mr Milei, early data for June suggest that inflation is edging up. Argentines are being hit with eye-popping energy bills as the government cuts subsidies that had kept prices low. Real wages are also starting to recover as workers lobby for higher pay, potentially raising other prices. Mr Levy Yeyati predicts that monthly inflation will hover at around 4-5% for a while. If that is correct, the risk of a sharp currency correction will grow.

Looming over all this is a thornier issue: what to do with the central bank and the peso. Mr Milei campaigned on a promise to blow up the former and scrap the latter, declaring that the local currency “is not worth crap”. These days his team prefers to talk about currency competition, in which dollars and pesos would both be legal tender. But no one knows the details of the plan or the monetary programme to stabilise the peso that would go with it. “Further work is needed in defining some of the key underpinnings,” the imf diplomatically concluded on June 17th.

Mr Milei, though not his economic team, seems particularly enthusiastic about a scheme he calls “endogenous dollarisation”. This would involve fixing the supply of pesos. When the economy grows, and more cash is needed, Mr Milei expects Argentines to use their own dollar savings for transactions. “The peso will become like a museum piece,” he said in mid-May. He would then close the central bank.

The imf seems worried. If Argentines believe the peso will end up in a museum, its supply could outstrip demand, stoking inflation. It is also unclear what would happen to the peso-denominated financial system. The imf instead enthuses about currency competition. Peru has such a system, with the sol and dollars both used. If Mr Milei insists on his scheme, it would surely be harder for his government to get new cash from the fund.

Mr Milei has done a remarkable job so far of discarding the fiscal baggage that has been weighing Argentina down. But mess up the big macroeconomic questions and that will count for little.