Can Argentina Dollarize? Should They?

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Can Argentina Dollarize? Should They?

Javier Melei is an extremely entertaining guy, between the chainsaw-wielding rallies, taking political advice from five clones of his beloved dog, Conan, and blatantly pandering to professional economists in Argentina who haven't emigrated or been institutionalized by giving speeches with lines like "the derivative is never worth more than the underlying asset" and "they will have to internalize their externalities".[1] He's now President-elect of the 24th-largest economy in the world, with a mandate to apply a hopefully-more-metaphorical chainsaw to Argentina's public sector.

That "24th-largest economy" point requires some footnoting: Argentina's GDP per capita went from 40% of the US level in the 1870s to 85% in 1905, before declining in relative terms for the next century-plus. At its peak, the story looked much like that of the US: abundant natural resources meant high net exports, providing capital for domestic investment. Meanwhile, an increasingly expensive labor force created an incentive for automation, and for moving up the value chain.[2] But it's tough to do that when the US is doing it, too, especially when a series of railroad bubbles had given the US a low marginal cost for transporting goods and the US's domestic market was so much larger, in absolute terms, than Argentina's.

The next century was a long series of disappointments; over that range of time, it's hard for any one disaster to account for a big income gap, since disasters are temporary (and the permanent ones tend to reveal that the previous status quo was the temporary feature, as when every crash in oil prices revealed how much worse the non-oil parts of Venezuela's economy were performing. So the main economic story for Argentina has been chronic under- or malinvestment (Argentina has lagged peer countries and the global average level of investment relative to GDP for decades).

Argentina's economic policy record is somewhat notorious; one problem with a low baseline level of growth is that it encourages policies that temporarily accelerate things but lead to larger problems in short order. There have been economies that grew through heavy borrowing; Japan relied on debt financing for much of its growth, Korea did the same thing a decade or two later, as did China another decade or two after that. And that makes sense: when a country has significant untapped investment opportunities, borrowing abroad is a sensible way to capitalize; the investments will turn out reasonably well, and locals will own the equity.

But relying on this can lead to a paradoxical problem: investment inflows cause the financial and real estate sectors to grow disproportionately, pricing labor out of the export sectors whose success led to those inflows in the first place. The end result is, typically, some beautiful new office buildings with 90% vacancy rates, and some kind of economic or currency crisis. Argentina went through this cycle in the 90s and early 2000s, followed by a painful reset. The country tried to manage around this, and its aftereffects, with a series of start-stop processes determined by the IMF's willingness to lend (often too much) and their insistence on particular reforms (of uneven effectiveness). When global growth was high, and other countries were bidding up agricultural commodities, the economy grew; when labor strife, regulatory changes, financial crises, or a hiccup in global demand hit, it shrank. Sometimes this led to truly perverse outcomes, like the time in 2008 when one-peso coins were more valuable than two-peso notes.

Moderate inflation is probably overrated as an economic problem; voters tend to hate it, but people tend to think about their pay in nominal terms, so an inflation rate of x% means that companies automatically cut their real payroll by x% and offset that cut with discretionary raises. So inflation slightly lowers the cost of taking a risk on hiring new employees, particularly in a country with strong labor protections. But high or uncertain inflation imposes high costs: everyone either has to adjust every single long-term contract to inflation-index it, or has to accept that the monetary part is uncertain. This imposes constant frictional costs.

One option for dealing with those costs is just to denominate transactions and savings in something more stable. But on an individual level, this, too, has risks; for some countries, one stage of a currency crisis is that banks impose limits on dollar-denominated withdrawals, sometimes followed by the announcement that dollar deposits will henceforth be converted into the local currency at the official (i.e. wildly overvalued) rate. It's a simple fact that a country going through a currency crisis is a country with a shortage of some currency it can't print, and the deposits held by local banks are a tempting source of emergency funds.

Milei's proposed plan is to skip a few steps and just straightforwardly dollarize the economy. This was slightly walked back last week ($, FT), when an economist who had published a whitepaper on dollarizing the economy declined an offer to head the central bank—but Milei later insisted on Twitter that closing the central bank remains non-negotiable.

One way to look at this is through the lens of globalization as an active force: trade agreements get signed, joint ventures launched, websites localized, supply chains globalized. All of this requires human agency, but none of it requires high-level planning; the planning and agency is a matter of accelerating the natural process of supply and demand finding an equilibrium. And that natural process tends to make every country's exports increasingly skew towards whatever they have a comparative advantage at manufacturing. Which means that as the economy has globalized, it has become more difficult to avoid particular locations when sourcing particular products. Some things can be made more or less anywhere, but get made in particular places due to path dependence (electronics assembly in China), labor cost constraints (apparel in poor countries with ports), or low energy costs (aluminum smelting in Iceland). And that has meant increasing dependence on the US as a financial center.[3]

A classic argument against tying a country's currency to that of another is that it makes it impossible to have an independent monetary policy. If the US has another burst of inflation and needs to raise rates, interest rates in a dollarized Argentina will go up just as much, even if Argentina happens to be in a recession. But judging by the long-term record, giving up control of some economic policy might have to move from the debit to the credit side of the ledger. The US doesn't do a phenomenal job at managing its own economy, much less ensuring economic stability. But in a competitive global economy, there are some markets in which US economic policy beats the local incumbents on both cost and quality.

Disclosure: I own an Argentinian equity ETF, albeit temporarily. This is not based on deep research into the country's long-term prospects, but on the more prosaic observation—reinforced by many years of watching prediction markets—that libertarians, like everyone else, really like expressing their affinity for winners on their side, but, compared to other groups, have disproportionately high purchasing power and a propensity to express opinions by buying financial assets.

  1. Note that the first of these lines is trivially untrue: a $100 strike put option on a $1 bill, expiring today, is worth about $99. But that counterexample is itself illuminating: the point of Milei's line is that the government, as a "derivative" of the people, can't somehow be more important than the people it represents. If the way to construct a counterexample is to imagine a government that is explicitly a bet against the people, it makes his point nicely. It's possible, though unlikely, that he used this line as one of those Trumpian efforts to take a claim that makes his own side look good, and then exaggerate it so the opposition corrects it but, in the process, keep repeating the things that make their side look bad. ↩︎

  2. These wage increases are partly driven by workers getting more skilled, but mostly by workers shifting to sectors that sell into a global market, and away from domestic ones. The workers who show up in factories have to come from somewhere, and they’re typically considering those jobs as an alternative to near-subsistence farming, domestic work, etc. Education, and worker quality more broadly, will play a role, but more in raising the ceiling for wages than actually setting them. ↩︎

  3. You could say that one of the US’s key exports is our reserve currency. There are two reasonable steady-states for a reserve currency: if it's issued by the world's most important economy, then that economy is going to be so naturally diversified that its idiosyncratic fluctuations will have the smallest possible effect on the global economy. The alternative is to have a reserve currency that's tied to no specific economy, either a digital asset with an algorithmically defined money supply or a precious metal whose supply is limited by geology and mining technology. Given how different these equilibria are, it's hard to shift from one to another. ↩︎

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In one sense, a good measure of progress in financial markets is that it's viable to make more and more specific bets. There's a profusion of ETFs, so if you decide one day that you're less optimistic about value and more on cybersecurity, you can seamlessly reposition. And there are many different options contracts, so if you have a highly specific bet on a specific price move on a specific day, you can pay for nothing except the upside from being precisely right.

On the other hand, the most profitable of these products, in the short term, are the ones that give retail investors the most leverage possible, often at the cost of blowing those same investors up. So: Nasdaq has listed a new set of options on popular ETFs, with more frequent expiration dates so more of these options can be the extremely volatile zero-days-to-expiration, or 0DTE, variety ($, FT). There are, hypothetically, many specific reasons you'd want to trade such options, especially if you're trying to isolate the temporary impact of a specific catalyst. But there is also, realistically, a great reason to trade these, in that they're an exceptionally efficient form of gambling with rapid feedback. It's sometimes frustrating that tools for sophisticated professionals can also make normal people's lives much worse through almost-but-not-quite no fault of their own (for details, talk to anyone who is responsible for cybersecurity at a reasonably large organization—the ability to link to arbitrary URLs in emails is actually pretty nice, most of the time, but when people insist on more or less automatically clicking on every link they receive...). In the case of finance, though, that's what makes a market: every dollar of negative expected value from a gambler is a dollar of positive expected value for a market-maker, and is thus $0.99 or so worth of adverse selection that this market-maker can tolerate in exchange for offering cheap liquidity.

Corporate Politics

The WSJ has a piece that's hybrid of a profile of Satya Nadella and some background on OpenAI's governance ($, WSJ). One thing the article points out is a good explanation for why Microsoft didn't have more influence and visibility: "Even after investing $13 billion, Microsoft didn’t have a board seat or visibility into OpenAI’s governance, since it worried that having too much sway would alarm increasingly aggressive regulators." There's also a PR element; Microsoft would prefer not to take responsibility for, say, a chatbot that will give you the recipe for napalm if you ask in a sufficiently manipulative way. There's a sort of corporate deism at work here, where the company tries to set in motion a process that will do what they expect without their intervention, but without the requisite omniscience it goes off the rails.

Disclosure: Long Microsoft.

Ads and Sports

One argument for running ads on major sporting events is that it's a way to bootstrap a conversation the next day: the game, and the ads, will be common context, and a mention of a funny ad is tantamount to at least one more ad impression. And this is actually priced in; it’s a rare case where broader targeting actually leads to a higher spend per ad, since an event with a huge audience implies that more of a given viewer's acquaintances watched the same event. The force pulling in the opposite direction is that hyper-targeted ads will be able to hit one specific viewer with the exact message they're statistically most likely to respond to. Amazon ran this kind of targeted ad on its Black Friday NFL game.

One question to ask here is: which category of advertiser is the reserve bidder who sets a minimum price for ad inventory, and which bidder provides the maximum economic upside? Brand advertisers tend to be less price-sensitive (they, in addition to their customers, respond to brands rather than purely numeric or value-add arguments). But the ROI on a retargeted ad, one with mediocre production values but perfect targeting, is easy to calculate. In the short term, the latter probably sets the minimum bid, which branded advertisers have to beat. But as that kind of ad gets more common, particularly for video content, sporting events that get captured by big tech platforms might end up monetized in roughly the same way that they were fifty years ago, by big national brands trying to get as much of the country as possible to talk about their ad.

Disclosure: Long Amazon.

AI Creating Jobs

More than 400 Federal agencies are trying to hire a Chief AI Officer by yearend. The linked article notes that the high end of the mandated pay for this role is lower than the lowest amount someone in the private sector makes with the same title. So one interesting result is that this role will have serious adverse selection: the people who take it are motivated by some combination of genuine patriotism and the inability to get a better-paying private sector role with similar responsibilities, so if it's not obviously the former, it will implicitly be the latter.

Marketing Real Estate

For years, some restaurants have been optimizing their meals to look good on Instagram: vivid colors and square plates are staples, but there are many other techniques. Now, offices are aiming for the same kind of aesthetic, with the same basic goal in mind: higher foot traffic from people whose presence is somewhat discretionary. One effect of Covid was a partly-permanent shift towards working from home and hybrid work, but one side effect of that was that offices have more competition, and have to step up their efforts to appeal to workers and companies who now have more choices.

Disclosure: Long Instagram’s parent company, Meta.