Juggling on a waterbed – Argentina’s managed exchange rate

Macro economic policy is like this: you’re juggling a whole bunch of balls while jumping up and down on a massive waterbed. It’s even more complicated that the analogy implies and we’re certainly no experts, but this is out take on Argentina’s current circus act.

In New Zealand, Europe and the US we’ve let the exchange rate ball drop and now it rises and falls with the waterbed. This is known as a floating exchange rate. In Argentina the exchange rate ball is still being juggled by government. This is a managed exchange rate. The government announces changes to the exchange rate like the Reserve Bank announces changes to interest rates at home.

To facilitate its managed exchange rate the government needs to offset foreign currency transactions by contributing funds of its own. This can cost a lot so in practice governments restrict citizens’ access to foreign currency. In Argentina if you want to travel overseas you need to make an application and this is not always granted.

The downside of devaluation

Sometimes the government may run out of funds, not be able to offset the foreign currency transactions and will instead choose to devalue the currency. This means accepting the Argentine peso is worth less, and paying pesos for other currencies. Argentina had a significant devaluation in 2002, which is about when the black market for US dollars started up, and the peso has been periodically devalued since.

Devaluation sends negative signals about a currency. If your money in your savings account might lose its value in future you feel less secure about saving. You might even choose to keep US dollars under a mattress rather than put money in the bank. Accessing US dollars to do this, when official access is restricted, is why we could exchange our US dollars for a lot more than the official rate, and enjoy steak for less.

If you’re selling products you’re also worried about devaluation. Supermarkets concerned the money they’re paid might be worth less in future will raise prices to compensate. This causes inflation, one of the bigger balls you juggle in macro-economic policy. Too much is very damaging for an economy. It causes uncertainty and precipitates more devaluation. Vicious cycle.

Climbing out of the cycle

If a floating exchange rate is off the table the only way to really get out of this inflationary cycle is if the government has a credible plan to bring the real value of its currency in line with the rate it’s managing it at. That might mean, for example, contractionary fiscal or monetary policy that encourages savings. These tools aren’t fundamentally different to what other economies, like the United States, have been using when the value of their dollar has decreased on the open market.

The Argentine government’s most recent policy to curb inflation is price controls. Key goods, which in Argentina include certain cuts of steak and yerba, the herbs for the all important mate, now have prices set by the government. Supermarkets like Walmart and Carrefour have been fined $750 million for flouting these regulations.

It seems foreign through our eyes to consider managing an exchange rate, because we long dropped that ball and left it to loll around, but there are reasons to do so. A currency that is too volatile on the open market can be damaging to an economy as everyone has to hedge at significant cost. Or you might want to balance benefits to importers and exporters. The high kiwi dollar is great for us when traveling, but not for farmers back home.

Theory asside you’d have to say Argentina is not managing its exchange rate effectively. The threat of devaluation, and the uncertainty that causes, means there’s dozens of illegal moneychangers on Florida street who offer us nearly half as much again as the official rate for our precious greenbacks. And the Argentinians who pay for our US dollars as mattress stuffers are doing so rather than investing in their own economy.

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