The Power and the Money

Macri and motivated reasoning

Abad and Maurer here, with some thoughts on the next 50 days. 

President Macri has only one chance at re-election. That is to villify his opponent. The markets tanked when it looked like Fernández might win, he has to say. Fernández will turn us into Venezuela. Fernández is corrupt. And Fernández is a sock puppet for the other Fernández, Cristina, who plans to eventually turn the keys over to her idiot son. 

In other words, he has to go negative in a way that would make Donald Tr ... well, in a way that Donald Trump would be entirely comfortable with doing. 

Now, the polls show that Macri is underwater by a lot; it is that they show Fernández breaking the magic 45% you need to avoid a second round. One poll had it 55% to 33%. Another put it at 49% to 32%. You can see a whole bunch of similar results here from Clarín. Worse yet, most of the public blames Macri for the crisis. 

So villifying Fernández probably won’t work. But it might. There is private polling data (obtained by Leticia Abad) that indicates he could pull it out. And the election is 46 days away (as of September 11), which is a long time in politics. People engage in motivated reasoning all the time. Macri could easily convince himself that mudslinging will work, and even if it doesn’t, he has to try anyway to keep those evil Peronists out of the Casa Rosada.

The thing is, Macri has to avoid that temptation.

Argentina’s creditors won’t talk to Macri unless the next administration gives at least its tacit agreement. Moreover, Argentina would be well-served by having the lame duck president rip off the band-aid. That would not just make economic sense, it would make it much easier politically for Fernández to fight political pressures to make things worse. 

In other words, Macri should admit that he is a lame duck (at least in private) and get Fernández on board. Hell, in the long run it might even get him a good spot in the history books. 

All he needs to do is overcome basic human nature and hope his opponent can do the same.

More on that in our next post ... 

Argentina tries to stem the panic

Leticia Abad and Noel Maurer here again, reporting on some news that while not unexpected, has arrived unexpectedly prematurely. 

Imagine you are a banker in the mid-19^th century. All of a sudden, you observe more and more people demanding that your banknotes be converted to hard currency. After a couple of days, this is getting serious and you see your reserves plummeting: this is a bank run!

If the bank were in a weak position to start with, then this bank run could have been warranted. The banker will stop paying when she runs out of reserves. But sometimes bank runs are just panic for panic’s sake. Then, as a banker you could refuse to convert these notes to restore sanity, to calm people down.

Now, replace “ban”k with Argentina. The bank run is a peso run. Welcome to President’s Macri’s life.

Since the last post, our dear country has not managed to hold a steady course. The Central Bank keeps on hemorrhaging dollars and technically the country has defaulted, well, selectively, according to rating agencies.

Right now, the federal government is facing substantial payments on its dollar-denominated debt over the next few months. (See the below chart.) That means that the federal government will need to dive into the market to get dollars make the payments. (The Argentine federal government, not surprisingly, collects tax money in pesos.) That will lead to one of two things: (1) A further fall in the value of the peso against the dollar, which would be very bad; or (2) A big drain on the Central Bank reserves as the bank provides the government with the dollars it needs, which would also be very bad, since those reserves are falling fast. 

So what to do? 

Well, ask creditors to let you postpone the payments.

On August 28th, to hold on to its foreign currency reserves, the government tried short-term debt management. It unilaterally extended the payment of short-term bonds on August 28th. That lasted a day. Then the government came up with a plan for further extending repayment — or as they call it a“reprofiling.”  (Check #reperfilar for the corresponding memes).

My favorite: Reprofiling is the new “we need to talk.”

The renegotiation applies only to firms; individual creditors will receive payments as expected. This move should free up around $13.4 billions of reserves.

In other words, let’s kick the can down the road!

This strategy to ease the peso run failed quickly. The dollars kept on leaving the Central Bank’s vault.

To quell the panic, the Macri administration’s second move was the national equivalent of having the banks close their doors to depositors during a run. Capital controls ensued, first for foreign banks to repatriate profits. Then yesterday (on Sunday!) the government issued an emergency decree establishing good ol’ capital controls. All firms now require authorization to operate in foreign currency. Individuals have a cap of $10,000 per month on how much money they can change. Today will be the opposite of a banking holiday, withthe Central Bank extended banking hours until 5 pm (normally banks close at 3 pm).

President Macri decided that it’s better to adjust now when he has lots of reserves than adjust later. Will that stop the panic and make Argentine and foreign investors calm down?

It is clear that this is a last resort, as President Macri denounced capital controls during his presidential campaign. Since the primaries, he is facing an uphill battle to, at best, make it to a second election round. Hence, he is trapped between being a president and a candidate. From the quasi-populist policies announced two days after the elections to the imposition of capital controls binding for firms, he is trying to stabilize the country in hopes of attracting more votes. At the very least, he is trying to avoid to leave De-la-Rua-style — i.e., in a helicopter — before the end of his term.

All this, of course, has implications for the election and what the next president will do. Wait for the next post!

Guest post: Gone with the PASO

Leticia Arroyo Abad here, our woman in the Southern Cone.

Argentines have been battling a recession, several mini-crises, and high inflation for a while now. The result was a resounding defeat for the incumbent administration in the recent primary elections.

The primary is called the PASO, for “Primarias Abiertas Simultáneas y Obligatorias.” In English, that’s the obligatory and open simultaneous primaries. Which means exactly what is says. All parties hold presidential primaries on the same day (simultaneous), in which any voter can pick any candidate for the nomination of any party (open), and in which all Argentine citizens are required to vote (obligatory).

Admittedly, the fine is only 50 pesos, which was about US$1.25 before the election, but we Argentines are public-spirited. Or possibly just angry at our politicians. Either way, turnout hit 75%. 

To the shock of precisely no one who was paying attention, unless you include all the people who are paid big money to pay attention, the defeat for the ruling party triggered a massive response in the markets. The following day, “Black Monday”, the peso plummeted to from 45 to 63 pesos per dollar before recovering to around 54. The MerVal index and government bonds suffered massive losses. And things would have been worse had the central bank not intervened promiscuously to prop up the peso. Here are central bank reserves over the past two months:

(Extra credit if you can spot the IMF loan poor President Macri accepted as the markets battered Argentina in mid-July.)

The panic also hit the banking sector. With the plunge of government bonds, a group of foreign banks demanded a buyback from Treasury (as part of an earlier repurchase agreement to boost reserves) that further depleted our national reserves. But hey, what was lost in reserves was more than won in public debt reduction. That is good news, right?

President Macri was not, shall we say, gracious in defeat. With evident anger (or bronca as we say it here), he blamed the electoral results on all Argentines. In a strange technical sense that is true, as in voters do indeed determine election outcomes, but it seemed like he was blaming the crash on the voters ... and that is not generally a good way to win votes. He did apologize for his unfortunate reaction later on.

Trying to get a the solid win over the opposition will be hard, maybe impossible at this point. Nevertheless, Macri is giving it a try. On Tuesday, the President announced a new economic plan. It includes slashing the value added tax on the consumer basket, increasing university grants for students, cutting taxes for small firms, and freezing gas prices, among other things.

The problem is that this administration doesn’t want to be populist. (Or maybe it doesn’t know how?) So the whole package just falls short. And the Argentine people know populism very well; a collection of short-term half-measures is unlikely to fool anyone. Moreover, the government is trying to please God and the devil at the same time. A spending spree, however temporary, will not meet IMF targets. 

Now, as of this past weekend, we have a brand new minister of finance, as the previous one was not happy with the new “populist” detour. Hernán Lacunza believes that the number one priority is to stabilize the peso using the Central Bank’s reserves as “that is what they are for.” 

One week after the shock, Argentina has a new minister of finance, a somewhat stabilized peso, looming IMF targets to meet, and half-baked populist policies to implement. This should keep the President busy but it is highly uncertain that it may buy him another term.

So what will the opposition bring? Well, we can talk about that in another post.

Why not just let the Argentine peso fall?

I wrote this almost a week ago, but forgot to hit “post.” With today’s further fall in the peso to 25 per dollar, it sadly remains relevant. So ...

Why is Argentina going to the IMF at all? Why not just let the peso fall?

Answer: currency mismatch. Argentina seems to be shot through with foreign borrowings. Some of these borrowings are hard to understand.

Other foreign borrowings are not as hard to understand. Consider the gross data on Argentine financing through international capital markets. When President Macri took office, the country regained access to foreign lending. It then proceeded to take full advantage of that new access to raise needed capital. Together the federal government, provinces, and the state-owned oil company (YPF) have borrowed about $48 billion (gross) under the Macri administration through the end of 2017. (There are credible reports that these figures may be understated by a factor of two.)

Now, I’m not saying that borrowing caused the run on the peso. Nor am I saying that it’s a huge amount for a ~$545 billion economy. But it would be rough if the capital suddenly stopped flowing, which is what would happen if the authorities just threw up their hands and let the peso plummet. Budget deficits would still need to be plugged and expiring debts would still need to be rolled over, only at much greater cost in peso terms. 

But wait it gets worse! Argentina’s financial system is heavily dollarized. That means people and businesses denominate their debts in dollars, not pesos. Why they do this is not clear: there are plenty of other countries with as checkered a monetary history, yet debts and contracts are made in the local currency. Nonetheless, many Argentine businesses write their debt contracts in dollars, even though most of them make sales in pesos. 

How serious is this problem? Well, I once again turn to the Argentine central bank. In 2016, 39% of manufacturing industry debts were in dollars, along with 37% of farm debts and 32% of service businesses. Only commerce (17%) and construction (12%) had less dollar debt … but even those numbers are pretty high. Twelve percent of construction business liabilities, the nontradable par excellence, are in foreign currencies?

Should the peso crash, those debts would become overwhelming. In fact, according to the Institute for International Finance, the situation has become a lot worse in the last two years: they report that a whopping 64% of Argentina’s combined government and corporate debt is denominated in dollars. Imagine if the value of 64% of your debts doubled over the course of a few days.

It follows that Argentine banks are exposed to depreciation. As of September 2017, 9% of bank loans were denominated in dollars, against 15% of their liabilities. The weight of those liabilities could soar if the peso crashed. Moreover, considering as most of those loans are probably to Argentine entities who earn in pesos, those dollars loans would start looking shakier as well.

In short, jacking up interest rates and going to the IMF is bad. But letting the peso just fall as far and as fast as the market will take it is also bad. It might even be worse. In other words, cry for Macri, Argentina: it is a terrible and unavoidable choice. 

More evidence that Trump caused the peso to fall

First, pray for Miami. I have a love-hate relationship with that city, even deeper than my love-hate with Texas. I would not want to live in that entire metro, not in Miami-Dade, not in Fort Lauderdale, not in Palm Beach. But my family is there along with seven million other people. They have not evacuated. But my brother is sheltering the families of two of his daughters at his house outside the flood zone; the third is an R.N. and she is on call, along with her police officer husband. 

Second, allow me to present some evidence that Donald Trump was indeed responsible for most of the weakness in the Mexican peso since he arrived on the political scene in mid-2015. The Mexican peso has strengthened over the past year. When we were there this summer, the peso rose above 5½¢ and stayed there. It had plunged below 5¢ after the election. This was good for Mexicans who wanted to buy imported goods, and I have to admit that Mexico City is still very inexpensive, but still. 

The rise means that the peso is all the way back to its level of January 2016, before Donald Trump began winning any primaries. It is not quite back up to the 6¢ level of June 2015, when Trump rode down that escalator. That is probably due to residual uncertainty regarding the NAFTA negotiations: markets are partially pricing in the chance that the negotiations will fail, thereby exposing Mexican producers to WTO tariffs when exporting to the United States. 

And so, a prediction. If NAFTA comes out intact from the negotiations, then the real exchange rate of the peso will return back to the level it had back in 2015. 

Do note that candidate Trump could move the market with his words; President Trump much less so. Bets are being hedged, but nobody believes that White House words carry any information anymore. 

The fall in the Mexican peso was good until Trump came along

The Mexican peso began falling well before Donald Trump came on the scene. Opinion varies on Trump’s responsibility for the fall between April and November 2016 (Kevin Drum and Boz make good cases that he did not) but his administration is pretty clearly responsible for the gyrations after Election Day.

Let’s grant that the peso’s fall from 7.4¢ in November 2014 to 5.4¢ in November 2016 had nothing to do with the U.S. election. Was it a bad thing for Mexico?

Well, let’s start with inflation. Did the fall ignite inflation?

Wait, what? Let’s close in on that:

Inflation fell during most of the depreciation. It only started to rebound around the time of the U.S. election. I suppose it is possible that there is some model here where inflation is somehow stored up and then rebounds, but absent a big rise in inventories I do not see the mechanism.

Maybe the reason inflation fell was that the central bank tightened in the face of the depreciation? Let’s then look at interest rates:

The story is similar. Interest rates stay low through most of the depreciation. They only start rising in 2016. The central bank seems remarkably unworried by the fall until the latter half of 2016 ... which (perhaps coincidentally) is around the time that Donald Trump’s role in the depreciation becomes a point of contention. 

What about consumer confidence? Did the peso fall sap the animal spirits of Mexican consumers? Maybe the central bank did not need to raise interest rates because Mexican consumers refused to spend. 

Huh. Not a whole lot there until Trump’s election.

Finally, we’ll take a look at real wages, as a proxy for the labor market:

In short, 2015 was not a bad year at all, and 2016 was not much worse.

Some people have reported big price hikes in Mexico in 2016, but I am skeptical. Imaginary inflation has been seen all over the world — not least around the time of the adoption of the euro. And I have been travelling to Mexico pretty extensively over the period without noting big nominal hikes, save public transportation ... which is a pretty salient price and could easily cause people to feel that there is inflation going on when there is not. 

Either way, I submit to you: the depreciation of the Mexican peso has been a good thing for Mexico. It helped exports and cushioned the fall in oil prices to no discernible economic harm. 

Observatorio Argentino 34: What is the opposite of blue?

The “blue market” was the name for the Argentine black market for dollars under President Cristina Fernández. It was called that because the blue marketeers used a blue marker to test whether U.S. $100-bills were counterfeit. On December 15, 2016, President Macri abolished exchange controls, letting the official rate crash, and supposedly ending the blue market.

Only, to my surprise, it turns out that there is still a blue market! The “official” rate right now is 15.6 pesos, while the blue rate is 16.0. That is not a big gap, but why is there a blue market at all? Who is changing money in this blue market?

Nobody seems to know. But the best guess is tax avoidance: people paying extra to avoid having to declare their dollars. I can understand that, but why then isn’t there a blue market in Mexico or Chile? Any explanations?

No, actually Trump really did drive down the Mexican peso!

Kevin Drum announces with much certainty that Donald Trump has nothing to do with the peso’s fall! Is he right?

No. He’s not.

It is true that the Mexican peso weakened in November 2014, when oil prices dropped from around $80 to $66 and analysts concluded that prices were heading further down. It is also true that the peso kept weakening for much of the remainder of 2015, for reasons which are unlikely to have anything to do with Donald Trump, even if the above graph might have you think otherwise.

But after that? Let’s start by eyeballing it. First you have the weakness in January and February, when Trump polls well and then, on February 1st, starts winning. After that the markets breathe a sigh of relief as Trump starts to attract opposition … until the day Trump cleans up in Pennsylvania (and DE, RI, CT, and MD) and makes it clear that neither Cruz nor Kasich can stop him. After that, some stability … until Election Day, 2016.

Sure, you can draw a nice line through the trend and say, “Nope, Trump had nothing to do with it.” But that makes the ups-and-downs look might coincidental. 

But it gets worse for Drum’s argument. The peso moved on individual debate performances. It jumped right to the minute when the election result became clear. It tracked events with entirely understandable precision. And academics took notice: for fancy econometrics making the point, see here and here.

Finally, theory. For Drum to be right, he needs some sort of causal theory, something that would predict a long slow decline with the rest being random noise. (Highly coincidental noise, but still noise.) In other words, he needs a hypothesis. Oil prices won’t do it; they were priced in early. There might be another just-so story out there. I’d be curious to hear him propose it. But it seems silly to look for one, when there is an obvious explanation that fits the data staring us all in the face.

Border adjustment, the Mexican peso, and Hoyt Bleakley

It now looks like the administration won’t (for now) be using its Economic Powers Act authority to impose a tariff on Mexican goods. Instead, he is going to ask Congress to create a border adjustment tax, which would stop American companies from deducting imports from their taxable income. At the same time, it would leave their exports untaxed. (Full explainer from Forbes, here.) 

So what would that do to the auto industry? Well, let us proceed in two stages.

1. What is the immediate impact on an American auto producer? Well, the border adjustment tax is less harmful than a tariff. The auto companies would not be able to deduct the cost of goods coming in from Mexican affiliates and suppliers, but they also would not be taxed on the cost of goods going out to Mexican affiliates and suppliers. But they would still have an incentive to source more inputs at home.
2. Except that the peso would fall (or the dollar would rise, same thing) in response to the tax. A 20% depreciation in the peso puts the auto company back where it started. 

But would Mexico allow the peso to fall that much? In the past, the Mexican central bank has acted terrified that depreciation would hammer Mexican corporations that had borrowed in dollars. That is a reasonable fear ... in theory.

In practice, it might not be. My friend and colleague, Hoyt Bleakley (with Kevin Cowan) looked at 450 non-financial firms in five Latin American countries. 

We consistently find that, contrary to the predicted sign of the net-worth effect, firms holding more dollar debt invest more than their counterparts in the aftermath of a depreciation. We show that this result is due to firms “matching” the currency denomination of their liabilities with the exchange rate sensitivity of their profits. Because of this matching, in equilibrium, the negative balance sheet effects of a depreciation on firms holding additional dollar debt were more than offset by the larger competitiveness gains of these firms.

In other words, depreciation might not be that harmful.

The other reason the central bank might not want to let the peso fall is fear of inflation. But that depends a lot on the reputation of the central bank and the structure of wage bargaining. Banxico is very credible and Mexico has weak unions, so while a fall in the peso will lead to a one-time increase in costs, it seems likely that Mexican workers would just have to suck up the fall in their living standards. It is hard to see how they could demand the kind of compensating wage increases that you would need to set off an inflationary spiral.

So yes, the peso could fall.

In short, the Trump tax would likely make Mexicans poorer with no compensating gains for American workers. But also no losses for fans of big American cars like the amazing Dodge Challenger, like my son. In other words, a gratuitous punch in the nose of those perfidious foreigners! And you can pretend that the tax flows are coming from those foreigners, when they are really coming from American consumers. 

Yeah, I can see why this might actually happen. 

Well, the currency markets have an opinion on the debate

So I took a peek at the Asian markets, and to the right you can see how the peso did against the dollar. The peso strengthed (down on this graph is stronger) 15 minutes in; it then soared between 9:30 and 9:45. It kept rising at a slightly slower rate until the debate ended at 10:40.

Looking over my liveblog, it looks like the rise started around the time the Fat Crybaby called a $13 million loan from his father “small.” 

Now, the move is not that dramatic. The peso rose from 5.0¢ to 5.2¢. But it seems as though people who have money at stake think the debate moved the needle. It also shows that people with money at stake do believe that a Trump administration would be a bad thing for that country’s economy. 

Colombian peso update

 Colombia did not redenominate its currency in 2014. The Santos administration says that the plan to chop three zeros off the money continues to be in play.

Short version of what happened: Congress resisted the cost and President Santos decided not to use his considerable legislative power to push the bill through. In February 2015 the country introduced a 100,000-peso bill, temporarily reviving the debate. But for the moment, nothing is in store. Given that Santos has a lot on his plate, I doubt it will happen for several years ... I would be surprised if it happens before the 2018 election.

Hope that helped!

Observatorio argentino 24: The blue market for the peso is not long for this world

I have a huge backlog of Argentina posts. Life and work kept me from posting most of them. I will start to try to rectify that.

I earlier mentioned my first contact with Argentina’s exchange controls, in May 2012, when I saw a Brazilian couple stopped by police and arrested on Calle Florida. 

In May 2012, the breach between the blue market rate and the official rate was not serious. It was still reasonable for a tourist to avoid the hassle. The business pages had stories about companies that were having problems with a lack of dollars, but nothing particularly serious and nothing that would affect day-to-day life.

By June 2013, the gap had become more serious. No tourist in their right mind would buy pesos at the official rate. For the rest of the economy, the economic effects were relatively small but beginning to be felt. Imagine, for example, that you were an Argentine manufacturer. Some of your inputs are imported. If you wanted to import them at the official exchange rate, then you would have to apply to the central bank. The red tape was increasingly onerous. (The negative effect of the controls on trade is part of Argentina’s ever-worsening beef with Uruguay. They have also brought down a host of WTO suits.)

It was possible for firms to work around the controls, but that was costly. There were two varieties of workaround. The first was to buy or contract with an export business which would earn dollars outside Argentina. Those dollars could then be used to purchase imported inputs. Pirelli, for example, makes tires in Argentina. It partnered with a honey exporting business in order to meet its import bills. As you can imagine, the honey exporters did not provide this service for free.

The second workaround involved the blue-chip swap market, in which a company would buy foreign securities with pesos and then sell those securities for dollars. That market, however, was costly to access ... after all, you had to convince somebody who owned foreign securities to sell them to you for pesos. They would not do so at the official rate.

Still, as late as last summer, the controls were more of an annoyance than a disaster. Companies that needed to import could do so, even if they needed to pay extra for the dollars and their shipments took forever to get through customs. Moreover, many imported inputs could be swapped out for local substitutes. Inasmuch as the Argentine authorities wanted to promote self-sufficiency, the implicit trade restrictions were a feature, not a bug.

There were some weird effects, of course. For example, demand for high-end cars soared. The cars were imported at the official rate but sold at the blue market rate, providing an irresistible bargain for anyone who earned in dollars. (Luxury cars were also considered an inflation hedge, but that was just people being silly.) In addition, luxury goods began to vanish, since there was no easy way to (say) replace an Ermenigildo Zegna suit with an Argentine substitute. But that was also minor: I still have two $200 local suits that I bought in Buenos Aires back in 2005. They started to generate lintballs fairly quickly, but they have not frayed. An annoyance, not a disaster ... and for a left-wing government you could even call the disappearance of imported luxury items an additional bonus.

The problem is that the macroeconomic imbalances have continued to worsen. The costs of getting dollars (or clearing customs) have gone higher and higher.

And so, since it turns out that Argentine-sold ketchup is actually made in Chile ... McDonalds has just run out of the red stuff.

OK, that is minor, and an Argentine substitute will be found pretty easily. But these sorts of problems are starting to pile up. At the limit, you make imports impossible and wind up with Venezuelan-style shortages, only without a giant oil export machine to cushion things.

Argentina is not Venezuela. The policy is fast-approaching its breaking point. The government is terrified of an inflationary spike, but there are worse things. (Like fuel shortages.) The recent liberalization is going to continue. Soon enough Argentina will be a normal high-inflation country, rather than an odd throwback to the 1970s. The liberalization will not be easy (the government needs the dollars to pay debts!) but the alternative is politically worse.

Either that or they will have to figure out how to make do without imports.

Observatorio argentino 20: The blue market for dollars

I just got back from Argentina. Great country. I could get a huge filet mignon for $19 in a very nice part of town. With free champagne.

The reason I could take advantage of cheap prices in Argentina was that I bought pesos at the “blue market” rate, 7.8 per dollar at retail rather than the official rate of 5.35. (That steak, for example, would have been $28 instead of $19.) As much as a bargain as that was, however, it would have been ever better in May 2013, when the blue market rate touched 10.5. ($14 steaks!) Since then, however, the peso has strengthened enormously.

But why has the peso strengthened? Beyond Brics suggests that the reason is that the Argentine government has cracked down on the market. The crackdown is real: I should not write about how I accessed the market, but I will say that it was a great deal shadier than the last time I was there in May 2012. (And let me say that the crackdown is not starting from an easygoing level: back then I saw a Brazilian couple arrested by police with dogs because they mistakenly thought they were dollar dealers!)

But is the crackdown why the peso has strengthened on the blue market? When law enforcement cracks down on illegal drug markets, a rise in the price of illegal drugs is taken as a sign of success. After all, the point of cracking down on illegal drug markets is to make illegal drugs harder to get and thus more expensive.

So ... if the Argentine government were succeeding in combating the illegal dollar market, shouldn’t the price of illegal dollars be going up rather than down?

Policy of attraction, part 3

 In comments, J.H. asks why the Phillipines didn’t adopt the U.S. dollar. After all, Hawaii and Puerto Rico did, as did Cuba, Panama, and the Dominican Republic. So why not the Philippines?

By the time the Philippine War ended in 1902, five different monies circulated in the Philippine Islands:

(1) Mexican silver pesos;
(2) Spanish silver pesos minted under the 1897 Royal Decree;
(3) Fractional currency;
(4) bank notes issued by the Banco Español Filipino; and
(5) U.S. dollars paid to American troops during the war.

The silver currencies traded at values that had little to do with their actual silver content; the Philippines were basically on a fiat money standard, with the difference that nobody was actually in charge of issuing it. Nobody liked that, so the U.S. had to decide between three different options. First, it could regularize the silver currency, basically continuing the existing system but under the control of a single mint. Second, it could introduce the U.S. dollar. (The U.S. was then on the gold standard. Dollar coins had a fixed gold value, and federally-regulated banks were required to back their note issues with gold or U.S. government bonds.) Third, it could introduce a separate Philippine gold-backed currency.

Why adopt the dollar? I give the floor to Representative Ebenezer Hill (R-Connecticut): “I want to say to every one of these representative from the Pacific coast that whenever they vote to put a new and strange system of coinage in the Philippine Islands is to build a fence between the trade of those islands and the trade of that coast.”¹ Since Republicans backed the permanent retention of the Philippines, such a position was not terribly surprising.

What might be much more surprising is that most of the support for adopting the dollar came from the Democrats, who were loudly and uniformly opposed to annexation. What explains that? Well, examine the following exchange:

William Jones (D-Virginia): I would like to ask the gentleman if he does not think by extending the coinage laws of the United States to the Philippine Islands and giving them our lawful money we could get out of there if we wanted to much more easily than if we gave them a distinctive currency which we would have to redeem and pay for?

Sereno Payne (R-New York): Oh, on the other hand, I think it would look as though we meant to stay there forever. [Laughter on the Republican side.]²

What was Jones getting at? How would installing the dollar in the Philippines make it easier to leave? Well, let’s go to Representative James Williams (D-Illinois):

A moment ago the gentleman from New York twitted those of us who want to get out of the Philippines with some sort of imagined inconsistency because we were supporting the substitute bill. ... I believe with all my heart that a greater mistake was never made than ever having landed a man to stay upon the Philippine shore after the Spanish fleet was destroyed. ... But I claim that when we leave we should leave behind American money as a stimulating agency for the expansion of American trade in the future. ... I say today that if you turn the Philippine Archipelago loose as an independent nation upon the Earth, it can not by any legislation float a token coin.³

In other words, the Democrats supported introducing the dollar because they believed that it would promote economic stability, thereby making it easier for the U.S. to get out forthwith. After all, Cuba had the dollar but the United States was smoothly on the way out. (The Democrats had no problem with Puerto Rico, although they were upset that the constitution was not extended to the island.) This position was honest: as I may talk about in a future post, the Democrats also strongly supported restrictions on American investment in the islands as long as they were under American sovereignty.

So why did Republicans prefer the option of a gold-backed Philippine currency?

The first problem is the Philippines were poor. One cent in 1901 was worth 27¢ in 2010 in the United States. In 1901, the price level in the Philippines was a lot lower than the price level in the U.S. (This is a general phenomenon: prices are lower in poor countries than in rich ones.) So one American penny bought at least the equivalent of fifty cents, whereas a Filipino centavo bought half as much. Losing the smaller denomination would have been a serious problem.

Of course, Philippine poverty wasn’t the only problem: Representative Hill proposed that the U.S. reintroduce the half-cent as an easy solution. The second fear was a bout of inflation. Puerto Rico had seen that during the changeover, as merchants attempted to charge as much in the new currency as they had in the old. (In theory, that shouldn’t happen. In practice, it did, and it forced an unpleasant political response.) William Howard Taft, the governor of the Philippines, was particularly worried; the last thing he wanted was popular discontent. Puerto Rico had handled the trouble, but Puerto Rico wasn’t coming out of a vicious guerrilla war.⁴

Finally, the Commission government convinced itself that a new peso could be introduced faster than the dollar. The Taft government (and potential American investors) were unhappy with the exchange rate fluctuations that afflicted the archipelago. It wanted a gold peso to stabilize the situation, and it wanted it quickly. If it could not get a gold peso, then it wanted the right to mint silver ones, but it wanted something.

The Democrats were a minority in Congress. They couldn’t pass a bill adopting the dollar in the House. In the Senate, Democrats were willing to fight for investment restrictions, but they were not going to do that over the currency. So bills passed both houses.

Except different bills passed each chamber. The House of Representatives voted 89-55 in favor a gold-backed Philippine peso, whereas the Senate accepted unanimously a proposal to coin silver. No compromise was forthcoming. As a result, the Philippine Organic Act of 1902 contained no monetary proposal, save an authorization to mint small change.

After another year of monetary chaos in the Philippines, the Philippine Commission went back to Congress. On January 22, 1903, the House of Representatives changed its position and voted 147-127 to introduce the dollar into the islands. The Senate then also changed its position, and voted on February 16th to create a gold peso. This time, however, compromise was forthcoming, in the sense that the House reversed itself. On February 24th, the lower house voted 139-104 to create a gold peso at a fixed rate of 2:1 with the dollar.

The introduction turned out to be messy and unsettled. It proved difficult to get the old silver pesos out of circulation; the exchange ratewith silver varied wildly; and managing the new currency proved more difficult than expected. It is far from clear that switching to a gold peso avoided many of the problems that switching to the dollar would have entailed. But there you have it.

In short, Taft and the GOP wanted to create a fixed exchange rate with the U.S. (believing that would promote trade and investment) but without the delay and dislocation that they believed would come from introducing the dollar. They then got all the delay and most of the dislocation anyway because Congress could not decide.

That said, it is also extremely unlikely that adopting the dollar would have made much difference. For it to have had a big effect before independence, you would have to be a very strong believer in the (excellent!) work of Andrew Rose on the effect of currency unions on trade to argue that having the dollar (as opposed to a fixed rate of 2:1 under American sovereignty) would increase trade by much. (In fact, Rose would expect it to make no difference; the fixed exchange rate between the U.S. and the P.I. was already a strong currency union.) There was a big financial crisis in 1919-22, in which the management of the fixed exchange rate was involved, but it is unclear at best whether the dollar would have really made any difference. The combination of postwar dislocations and mismanagement at the Philippine National Bank would have been a major problem either way; the dollar did not protect Cuba.

As for post-independence Philippines, well, after WW2 the U.S. spent a lot of effort to de-dollarize countries that used the currency. Considering how important capital controls were for postwar Philippine governments, it is hard to see why the Philippines would have been any different. Capital controls would have still been imposed and an American commission would have helped introduce a new currency, and the only difference is that the exchange rate would have fixed under the Bell Trade Act at 1:1 instead of 2:1. Perhaps the Philippines would have resisted de-dollarization (Panama did) but that seems very unlikely.

In short, the Philippine currency embroglio probably belongs in the list of Great Debates That Turned Out Not To Matter. But it get the world some coins that it otherwise would not have had, and now you know why.

Bolivian energy and the neighbors

 The New York Times has an article today entitled, “Neighbors Challenge Energy Aims in Bolivia.”  It is quite informative.  But it gives the wrong impression about the effects of Bolivia’s energy policy under Evo Morales.  The article makes it seem as though Bolivia shot itself in the foot by nationalizing the gas.  That is probably not true.  Rather, Bolivia has shot itself in the foot by refusing to build a pipeline to Chile.

Argentina’s energy policy has nothing to do with Evo.  In fact, inasmuch as Argentina has a coherent energy policy, it currently revolves around importing more Bolivian natural gas. Its roots lie in the peso devaluation of January 2002.  The government froze the peso-price of natural gas, in order to protect Argentine consumers who were already suffering an economic downturn considerably worse than the Great Depression.  The effect was to knock down the residential gas price from $1.88 to 66¢ per MMBTU. 

That wasn’t a problem until the southern hemisphere winter of 2004, when gas companies cut supplies to large industrial customers. After all, they could get much higher prices from exporting the gas to Chile.  Well, the Kirchner administration reacted much as you’d expect:  they banned gas exports. The Interior Minister of Argentina apologized to the Chilean government for the interruptions — but in May 2005 the Argentines once again slashed exports to Chile. The story repeated itself in 2006, when Argentina cut exports altogether for two weeks.  In fact, Buenos Aires added insult to injury when the government raised export taxes from 20% to 45%.  

Eventually, however, as the economy recovered, Argentina stopped being an exporter.  So the Fernández administration began to walk back the policy.  First, she allowed prices to rise to around $2.50 per MMBTU. Second, she created incentives to increase the domestic supply.  Finally, she moved to try to lock-in relatively low gas prices from Bolivia. Argentina imports LNG, but it costs twice as much as Bolivian gas.  The country’s LNG terminal offers a useful hedge against any Bolivian attempts to renegotiate the contract, but both parties would prefer to buy Bolivian gas for $5 instead of Trinidadian gas at $10.  (In fact, the terminal goes unused for long periods.)  

What about Brazil?  Well, what about Brazil?  It is true that the nationalization provided some impetus for the country to become self-sufficient, but less than you might think.  First, the Brazilians pushed back hard, even threatening to dismember Bolivia if it messed with the price or volume terms of the contract.  And Brazil won.  So while Petrobras may have been disillusioned, the situation worked out well from Brazil’s point of view. 

In fact, Brasilia had a good reason to want to allow Bolivia to retain more of the rents from resources, as long as Brazilian consumers weren’t affected.  Simply put, the bet was that a wealthier Bolivian government would result in a more stable Bolivia, and it’s politically easier for Brasilia to aid La Paz by resisting pressure to defend Petrobras profits than it would be to write checks.  The logic is identical to that behind the 2009 renegotiation of the Paraguayan hydropower contract — the primary difference being that since Brazil initiated the hydropower deal, it has been able to extract more political benefits from Asunción than it has been able to receive from La Paz.

Now, many people in Brazil say that Petrobras is upping domestic production in response to Bolivia’s tax hike. It may even be true.  But we don’t know!  Domestic exploration was good business with or without  Evo Morales.  The increase in Bolivia’s government take made it more so, but we don’t have the numbers to say that domestic supply would not have increased regardless.  I’m not faulting the article;  it’s a subtle point. I am faulting them for getting Argentina backwards ... but with Brazil, we just don’t know if Evo really mattered.

Chile is where the article is spot on.  After Argentina cut the taps, the Chilean government attempted to strike an agreement to build a pipeline from Bolivia, but the negotiations ignited a firestorm in Bolivia.  The anger surged over the fact that the pipeline would pass through territory that Chile had seized from Bolivia in 1878.  Horrors!  The Chilean government periodically floated a trial balloon of transferring a strip of land along the Peruvian border to Bolivia, but Lima protested, since Chile’s far far north had been originally seized from Peru. 

Nobody in Peru seriously contested the border ... but accepting a century-old annexation and allowing the annexed land to be transferred to a third country were very different things.  After a brief and goofy Bolivian flirtation with the idea of building an underground pipeline that would surface far out to sea, the idea died. And thus Bolivia lost a natural market, and whatever possibility it had of producing LNG. 

The article makes no effort — not that it should! — to produce a cost-benefit analysis of Bolivan policy for Bolivia. The country lost opportunities in Chile and it may have lost opportunities in Brazil ... but it got a lot more revenue at a politically-dicey time. That, I have to say, is not nothing. 

What should Evo do now?

Finally! The bolívar falls

  So he did it.  Finally.  When I was last in Venezuela, everyone was puzzled as to why the Chávez government hadn’t already devalued.  What was the political gain?  What was the economic rationale?  The consensus seemed to be that the reason was a combination of an ill-thought-out attempt to repress inflation by subsidizing imports and the ability to give rewards to favored political groups by granting access to foreign exchange at the official rate.  After all, it is a hella big reward to be able to buy a dollar for only 2.15 bolívares instead of 5.6. 

Now it looks like the country will have three exchange rates:  2.6 for “essential items,” 4.3 at the new official rate, and something like 6.0 (for now) at the exchange rate that must not be named.  No, seriously.  It is illegal to discuss the parallel market, let alone trade in it.  (Scroll down to “Conversion and Transfer Policies” at the link.)   

Anyway, the move is long overdue, but the continuation of the parallel rates will continue to give the government a nice tool with which to reward its friends and punish its enemies.  Daleyismo, indeed.

Is the madre patria scamming the Républica Bolivariana? Probably not.

  Over at Caracas Chronicles, they’re perplexed by a deal just signed to build a combined-cycle gas turbine power plant in Cumaná, Venezuela.  The Spanish contractors, Iberdrola and Elecnor, want to charge €1.45 billion to build two 500-MW plants.  The cronologistas caraqueños have done some digging, and found that €1,450 per megawatt is a lot to charge for a CCGT installation.  The closest was a €1,225/megawatt project in Algeria.  The highest that I knew of before they started investigating was a UAE project that came in around €890. 

They conclude corruption.  Are they correct?

Well … maybe.  But to be fair, I suspect not.

Venezuela, you see, maintains exchange controls.  Official transactions need to be made at the approved exchange rate.  On the one hand, this shouldn’t bother the contractors all that much:  they’re getting paid in euros, and the price of imported equipment is the price of imported equipment regardless of the denomination.  The problem, however, is that the relative price of all of their domestically-sourced inputs will be much higher.

Think of it this way.  Imagine you imported €1000 worth of machinery to Venezuela in 2004, after paying Venezuelan tariffs (around 20 percent) and taxes.  In that same year, a manufacturing worker cost €7,388 to employ for a year at the official exchange rate.  You could buy a worker-year for 7 units of machinery.  By the middle of 2009, after several years of high inflation in Venezuela, that same worker cost €12,720 to employ — a worker-year now cost you the equivalent of 13 units of machinery.  Unless you figured out a way to use half as much labor as you did in 2004, your labor costs (in euros) have just doubled.  (All data comes from the Banco Central de Venezuela.)

In fact, the same problem applies for all domestic inputs.  According to the Venezuela central bank, the bolívar cost of construction materials (including taxes) rose 230% between 2004 and the middle of 2009, while the official exchange rate remained the same.  That’s going to further drive up your costs.  

If it turns out that the Bolivarian Republic has agreed to let the contractors use the parallel exchange rate to purchase bolívares, then this analysis goes out the window.  But if the contractors have to use the same exchange rate as everyone else when buying local inputs, then the price that they are charging for the plant seems entirely reasonable ... even without taking into account the political and economic risk.  (Will PDVSA pay everything up-front?  Will inflation in Venezuela accelerate?  Will there be labor trouble?)   

In other words, unless the contract exempts the Spanish companies from exchange controls, then I doubt that there is much corruption to be seen in this case.  Bad economic management yes, corruption no.   

Does anyone have more details about the contracts?

Philippine economy watch

  The latest figures indicate that the Philippine economy has started to shrink.  Truth be told, I'm surprised that it took so long.  The Philippines may be relatively less dependent on exports, but 38% of your economy is still 38% of your economy.  Meanwhile, the country is highly dependent on remittances sent home.  Latin American countries have seen such inflows plummet.  In the P.I., though, they've held up. 

Luckily for the Philippines, there isn't too much evidence that the place suffers from the strictures of emerging-market Keynesianism.  The yields on Philippine bonds rose at the bad economic news, presumably on anticipation of more government debt issues to combat the downturn, but only by 5 basis points.  That really is not a lot.  So, not much sign of crowding-out so far.

The peso fell, but that's probably a good thing.  It's good because it gives exports a filip and increases the domestic value of remittances.  It's bad because as of 2007 the Philippines owed to foreigners $23 billion in debt securities and $40 billion in other debts. 

We will see how it shakes out. 

The Barber of Buenos Aires

On March 1st, 2005, President Nestor Kirchner effectively repudiated Argentina's obligations to those bondholders who refused its final offer to restructure its debts. 

Four years earlier, during the chaotic month of December 2001, Argentina defaulted on its dollar-debts. Over that evil month, the economy was reduced to barter, mobs sacked bank buildings, and the country went through five presidents in eleven days ... starting with the unlucky fellow in the blue shirt, Fernando de la Rúa. 

After President Néstor Kirchner took office in 2003, Argentina began negotiating over the debt in Dubai.  The Argentine side did everything possible to flummox its creditors, up to and including bringing very scantily clad female “assistants” to meetings with high-ranking American women.  The Argentine chief negotiator also played doornail dumb, honestly confusing the Americans and Italians across the table (unsurprisingly, the half-naked assistant ploy discomfitted the Americans rather more than the Italians) about whether he was uncannily brilliant or honestly didn't understand what a bond was.  (I've met the man, and I don't know either.) 

The Argentines put a truly fascinating offer on the table:  the creditors would forgive past-due interest would be forgiven, and the old bonds would be swapped for new ones worth 35 cents on the dollar.  In return, however, the new bonds would include a GDP “kicker.” The kicker — pronounced “keek-care” by everyone involved — promised the creditors additional payments equal to one-twentieth of the dollar value of all GDP growth above a initial threshold of 4.2% per year, which would eventually fall to one-twentieth of all growth over 3%. 

The creditors rejected the offer, preferring a “haircut” of 40% on the face value of the debt, no interest-forgiveness, and no kicker.  In response, Kirchner told them, and the IMF, and the U.S. Treasury, and eventually even President Fox of Mexico (don't ask), that the bondholders could take his haircut or drop dead.  On March 1st, 2005, the president finally told the holdouts to drop dead, and repudiated their bonds.

Below my friend Aldo contemplates the question: was that the right thing to do?

A year ago, I would have unhesitatingingly answered, “Yes.”  Now, I still think it was the right thing to do ... but I'm worried about what the Fernández Administration intends to do with its hard-won fiscal freedom.  More below the fold.

Dolarización y pesificación en el extranjero vecino

The Dominican Republic, like much of the extranjero vecino, is economically-married to the United States.  Far more so, in fact, that any of the Russian Federation’s near abroad.  The U.S. absorbs 72% of the country’s exports and provides 48% of its imports.  Americans and Dominicans resident in the United States make up 38% of all tourist arrivals.  Finally, and most strikingly, the huge hole in the Dominican Republic’s trade balance left after export sales and tourism receipts is plugged by remittances from Dominican workers living in the United States — an amount equal to 7 percent of the country’s GDP last year. 

The relationship goes beyond mere commercial convenience:  under CAFTA, Washington effectively sets Santo Domingo’s investor protections, labor standards, and environmental regulations.  Eat yer heart out, Vlad.

Still, there is one way in which the United States is conspicuously absent from Dominican life — the main currency is the “gold peso,” not the greenback.  That also wasn’t always true:  between 1905 and 1946, the Dominican Republic used the dollar as its currency, and if anything, the economic relationship is closer now than it was then.  This brings up three obvious questions, of course.  Why did the D.R. reintroduce its own currency?  What effects did that have?  And should it go back to the dollar? 

I’ll try to take a stab at all three below the fold.