otto1

Argentina's New Forex Policy in 3 Words: STUPID STUPID STUPID

By Otto Rock

March 15, 2008

Here are a few two year charts that map how some local currencies have done against the dollar.

Here's the Brazilian Real (approx 20% appreciation)

The Chilean Peso (approx 18% appreciation)
Here's the Colombian Peso (approx 10% in two years, but 23% from that peak)
Now the Peruvian Nuevo Sol (approx 16% appreciation)
And to give some global context, here's the Euro's perf against the greenback in the same two year period (approx 21% appreciation)
Meanwhile, Argentina's Peso has done...well..this;
While the vast majority of world currencies have appreciated considerably against the US Dollar, the Peso in Argentina has actually lost ground against the greenback to the tune of around 2%.

I've been through the "whys" of this monetary policy before, but in a nutshell Argentina wants to keep its currency artificially weak so that its exports remain competitive. The fact that it doesn't necessarily change anything (I've previously argued that one as well) doesn't seem to worry them....so be it.

I've also argued in other places that Argentina is setting itself up for a speculative attack on its currency from overseas investors. Peru is the latest regional state to have made the complaint that foreign hot money has been washing in and overcooking its forex market. Well, it looks like Argentina has not just ignored this threat but has just thrown the door wide open to the speculators and pinned a sign saying "please take my money" on its back.

Bloomberg reported today that Martin Lousteau, Argentina's minister of the economy, plans to sell ArgP$40Bn into the foreign currency markets this year to keep the Peso weak. But this time they aren't just going to emit Peso debt but use tax revenue pesos to buy the dollars, the idea being that they can artificially weaken the currency without printing more currency and adding to the country's inflation problem (and hey, it's a problem).

Sounds fine, no? You get to 1) up your dollar reserves, 2) keep your currency nice and weak and where you want it and 3) don't add to M2 in pesos, thus lessening monetary inflation pressures.

Well, apart from the obvious inflation problem a weak currency causes to a country with a strongly growing GDP (country gets richer, country likes that 42" flatscreen digital TV they make in Japan, country starts importing shiploads of stuff, country pays through the nose for foreign goods in its local currency cos the damnfool gov't won't let the Peso go from 3.15 to 2.80 vs the dollar etc etc), the chances of being openly gang-raped and left with sore nether regions are multiplied tenfold when you start playing forex games in the big leagues instead of just pumping out the pesos to the unsuspecting locals and sterilizing the transaction.

How it happens is like this: Argentina wants to sell ArgP$40Bn in a year...that's ArgP$3.33 a month...let's call it a billion dollars' worth to round up a bit. So Argentina trots over to the open forex market and finds a buyer for its pesos. Ka-ching, dollars change into pesos at 3.15/1, and everybody's happy.

But hold on a minute; if you were the buyer, what would be the attraction in buying a currency that wasn't planning on going up in value? Surely you'd be a buyer in the Peso for a reason, no? You'd like the Peso and happily sell your dollars if you thought it would get more valuable later.

So what happens if you, as Señor buyer, decide that you don't just like the Peso but you REALLY like the Peso? The Argentina government goes to market and sells its ArgP$3.33Bn for the month, and you go, "Hey! wait up dudes!! I haven't finished buying those yet! Don't run away, sell me another 3 billion, yeah?"

Argentina says, "Sorry dude, ain't got no more right now....I'll sell you a few next month ok?"
Señor Buyer, "Hey dude, that's bogus. Anyone else wanna sell me some?"
Private bank #1; "Yeah, I got 500 million of them, but I won't sell 'em so cheap. I'll give you 3.1 of them for a buck."
Señor Buyer, "Yeah ok, it's a deal."
Private bank #2; "Dude, you can have half a billion of my Pesos at 3.05 if you like, yeah?"
Señor Buyer; "Cool, deal...here's the moolah."

Now all this time Señor Buyer's feeling happy, cos he bought 3.3Bn pesos at 3.15, then managed to bring down the exchange rate by buying a few more at lower prices. So if he cashes in his original buy at the latest deal price of 3.05 he makes 10c on every Peso he bought from the gov't. And when your talking 10c X 3.3Bn, that's a tasty profit.

But the gov't aren't so happy, they see what's been going on since they left the market and go,
"WHOAAAA! Bad karma, maaaaaan! This whole thing was supposed to keep the Peso weak, and now look what's happening...SheeeYIT! We're gonna have to sell some more Pesos."

So the gov't goes back to market and sells another 3 billion or so. But Señor buyer isn't just any old buyer with a deep pocket. He's a hedge fund with REALLY deep pockets, and he smells serious profits here.

Señor Buyer; "Hey, this is SOOOO cool. These dudes are selling me lumps of cheap currency, but not only that, they've already told me how much they're going to throw at me in the whole year. They have ArgP$40Bn to sell. Hold on, let me check how much I've got here. Okaaaay! Way cool. I've got TWO HUNDRED AND FIFTY BILLION DOLLARS HANGING ROUND HERE! All I have to do is buy every single cheap Peso the Argentine gov't offers me, then buy more and more and more until they can't defend it any more! Sweet! Then it goes to 2.80 or so, up 10% more or less, and I cash in my chips....They sell me 40 billion chips and i make 4 billion profit without breaking sweat."

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Moral: Argentina is now officially playing with fire. It doesn't take Einstein to work out that the Peso is lagging behind all other regional currencies (check those charts again), and by going to the open foreign exchange market with a fixed amount of Pesos to sell they are making a huge tactical mistake. The big rumour a couple of weeks ago was that economy minister Lousteau was very close to resigning. When the forex market has finished with him and his half-baked plan, he might just get fired first.

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