MAGA down south

Before you read this post, please first read this post from 18 months ago. We are back in Argentina, and there have been some notable changes since our last visit.

By far the most significant change is Argentina's new President, Javier Milei. He's a libertarian and believes strongly in limited government and free markets. He is attempting a hard, far-right turn in Argentina's left-wing-damaged economy, which, if successful, could have ripple effects throughout the globe. He's only been in office since December, so the results are only visible if you know where to look, and I'll expand on that later. His objectives are straight out of the libertarian, free-market playbook: shrink Argentina's bloated government, kill inflation, gut regulations, eliminate subsidies, and root out corruption.

Since our last visit, the price level in Argentina has gone up over 4-fold; in percentage terms that's 4,430%. But the exchange rate has only increased almost 3-fold, or 260% (from 300 pesos per dollar then to about 1100 pesos per dollar now). As a result, Argentina is more expensive for a US tourist today than it was then. But it's still pretty cheap. The fish BBQ for four (actually four of us couldn't finish it) we had back then was $33, now it's $47. Excellent wine back then was $27, now it's $39 at our favorite Buenos Aires restaurant.

The most curious thing is that back then the largest denomination peso bill was 1000 pesos. A 2,000 peso note was subsequently released, but they are few and far between. In fact, I have only seen one after a week of looking—and I have yet to see any smaller bills. The 1000 peso bill today is worth about one US dollar, so let's call it Argentina's one dollar bill, and it's effectively the only bill you will see in circulation. Virtually all cash transactions are conducted with this bill, which means that everyone is walking around with a huge wad of $1000 peso notes in their pocket or purse. This also means that credit cards are essential for anyone expecting to make a payment of more than, say, $40-50 dollars.

Ubers are all over, and they are unbelievably cheap. My most expensive ride took us across town for about 20 minutes at 1:30 am. Uber charged me $5. I couldn't resist giving the driver the maximum tip Uber was willing to allow: $2.50. I would have loved to see his face when he saw that pop up on his screen! Most other rides of a couple of miles cost less than $2. Today's lunch at our small local hotel consisted of a glass of wine, a huge milanesa with an equally huge portion of real mashed potatoes, and an empanada. Total cost $12.

Any American who has heard of Milei will want to know the answer to this question: are the people willing to undergo a significant degree of hardship while he implements his draconian policies (e.g., slashing government spending, eliminating subsidies, firing tens of thousands of government workers, eliminating rent control)? Right now there is no question they will endure, because they know he is doing the right thing. Besides, they've suffered through so many hardships that one more is not going to be a deal-breaker.

I got together with a group of 8 local friends last night to talk about this and other things. The evening kicked off around 10 pm with some wine and hors d'oeuvres, followed by a delicious asado (bbq). Followed by more wine and some heated discussions. They were all quite positive about the future. I got back to the hotel at 3:20 am. I'm still recovering, but they all had to work today. These are the things I love about Argentina: great food, great wine, and great friends. Unfortunately the economy is anything but great.

Milei really should adopt Trump's MAGA slogan: "Make Argentina Great Again."

Moderate growth and disinflation still alive and well

A quick update to focus on some market-moving stats released today.

Chart #1

Chart #1 shows the results of the March survey of purchasing managers in the service sector (by far the largest part of the economy). It is consistent with the view I've maintained for well over a year, which is that the economy continues to grow at a non-spectacular pace.

Chart #2

Chart #2 shows that the number of firms that report paying higher prices continues to decline. This same statistic surprised to the upside in January, thus fueling speculation that maybe the Fed was right to move slowly on rate reductions. But as often happens, sudden jerks in monthly numbers are just flukes and subsequently reversed. Inflation pressures remain quite subdued; disinflation is still in place.

On balance, the picture is one of an economy that continues to grow while inflation continues to subside. The market, unfortunately, continues to harbor a long-ingrained reflex that says that in order for inflation to decline, the economy needs to weaken. Not so. Inflation is not growth-friendly. Low and declining inflation and moderate to strong growth can coexist indefinitely if the Fed is acting correctly.

Nothing in these recent stats argues for the Fed to refrain from lowering short-term interest rates. 

M2 update—still looking good

Today the Fed released the February money supply data, and there were no unwelcome surprises. M2 continues to shrink relative to the economy, and that's the reason inflation is likely to continue to fall.

Chart #1

Chart #1 shows the recent history of currency in circulation, which represents about 10% of M2. It rose at a fairly constant 6.6% annual rate from 2010 until early 2020, then surged (as did M2) from March 2020 through early 2021. I've assumed for years that this measure of the money supply is also a reliable measure of money demand, because people hold currency only if they want it. (Important note: there is no direct measure of money demand, and that's why it's hard for the Fed to keep the supply of and the demand for money in balance.) Any rational person with unwanted currency would simply return it to a bank in exchange for an interest-bearing deposit of one form or another. 

So the message of currency is that the demand for money exploded in the wake of the Covid crisis; everyone wanted more cash because there was so much uncertainty. And besides, it wasn't easy to spend money back then if you couldn't leave your home. But things started changing in early 2021 with the introduction of vaccines. Life slowly started getting back to normal. The demand for money began to subside. Today, currency in circulation has fully reversed its "bulge," and is back on its 6.6% annual growth track. 

Most important is the fact that if money supply and money demand are now roughly in balance, as seems to be the case, there is no reason to expect a meaningful change in inflation.

Chart #2

M2 grew at a 6% annual rate from 1995 through 2019. It then surged by some $6 trillion over the next two years, propelled by $6 trillion of government "stimulus" spending which was monetized. Deficit spending at all other times in recent history has been financed by selling Treasury debt. Not so this time, when the spending was effectively financed by newly-printed money. 

The initial surge in M2 was not inflationary because, as currency in circulation tells us, the demand for M2 was intense in the first year of soaring M2. But as the demand for money began to decline in 2021, excess money became inflationary as people began spending their surplus cash. This, coupled with supply bottlenecks, created a classic "demand-pull" inflation: too much money chasing too few goods.

M2 growth since early 2022 has been flat to negative, thanks in large part to the Fed's belated decision to jack up interest rates. Higher interest rates made M2 money more attractive, effectively neutralizing in large part the huge excess of M2 at the time. Although there is still some "excess" money according to this chart, it is not a source of inflation because interest rates remain high: extra money supply is countered by the extra demand for money that results from high interest rates.

Chart #3

Chart #3 illustrates how changes in M2 growth tend to precede changes in the CPI by about one year. That relationship appears to have broken down over the past 6-8 months, however. I think the reason for that is that the CPI is being overstated by the way the BLS calculates shelter costs. The red asterisk shows the year over year change in the CPI ex-shelter (1.8%) as of February '24; that's much more in line with the growth of M2. And it further suggests we have continued disinflation in the pipeline since shelter costs are almost surely going to decline over the next 6-8 months. 

Chart #4

Chart #4 shows another way of calculating the demand for money. It is simply the ratio of M2 to nominal GDP. You can think of it as a measure of how much of one's annual income one wants to hold in the form of money (cash, and cash equivalents). Here it is easy to see the sudden and tremendous surge in money demand in the early months of the Covid crisis. Then, starting about a year later, we see money demand plunging. At the current rate it should return to pre-Covid levels over the next year or so. We're almost out of the Covid woods, in other words.

Many will call this a "soft landing" or "no-landing" scenario. Because it will be the first time the Fed has wrestled inflation down from uncomfortably high levels without also triggering a recession. And the reason for that is the Fed's "abundant reserves" policy, which avoids creating a shortage of liquidity in the banking system.