Walter Molano | Great expectations for Argentina

In 1976, Robert Lucas, an economist at the University of Chicago, wrote a seminal paper challenging some of the tenets of modern macroeconomic theory.

Economics had undergone a significant revolution during the post-war period, as theorists cobbled together many of the concepts that had been laid out by John Maynard Keynes in his 1936 groundbreaking book, The General Theory of Employment, Interest and Money.

Armed with reams of economic data that had been produced by wartime production offices, which were continued after the war, and the computational tools offered by computers, economists were able to run complex models to predict how economic policies would affect outcomes.

Governments around the world assembled vast planning ministries to shape their countries economic development. The concept even made it into popular culture. Issac Asimov published a series of novels, known as the Foundation Trilogy, about the introduction of an algorithm that would explain human behaviour. Such policies became the basis of the five-year plans that proliferated around the globe.

The problem is that they rarely worked. Hundreds of billions of dollars in resources were squandered away in mindless bureaucratic projects. This is where Robert Lucas joined the narrative. He explained that while the models used past data to explain what had happened, they would be flawed in predicting what would happen, because people would temper their behaviour on their past experiences. The concept became known as rational expectations theory, and it was the basis for him being awarded the Nobel Prize in economics in 1995.

In all fairness, this was an important aspect of Asimov’s Foundation Trilogy. The novel’s algorithm had an important flaw, known as the uncertainty principal, whereby self-awareness makes collective actions unpredictable. Today, it is commonly known as reflexivity, and it is a concept that has been popularised by George Soros.

Nevertheless, it is an important aspect of economic policymaking. To put it in layman’s terms, reputation is a key aspect in explaining the effectiveness of economic policies, particularly monetary policy.

The problem is that Argentina’s monetary authorities have no credibility, and the population knows it. This is why the International Monetary Fund’s, IMF’s, US$57-billion standby facility was completely wasted.

Central banks are a relatively new phenomenon. The first institutions were established on the eve of the Industrial Revolution. The Swedish Riksbank was the first formally recognised central bank, established in 1664. The Bank of England was chartered almost three decades later in 1694.

Up to then, commerce was relatively limited. Communities were mostly self-sufficient. Barter was a common form of exchange, and there was enough silver and gold to sustain the small amount of long-distance trade. However, the advent of new transportation technology and products brought on by the Industrial Revolution fuelled the demand for money and led to the introduction of fiat or paper money, which created the need for some form of regulation.

At first, central banks were clearing houses that facilitated transactions between issuing institutions, such as banks, counting houses and local governments. However, as they increased their oversight, it was inevitable that they would take over the issuance process.

Soon central banks began to proliferate around the globe. The United States did not create its central bank until 1913. Even though these were new institutions, given that fiat money has no intrinsic value, they needed to exude a great deal of confidence in order to engender the trust of the population. The problem is that the Argentine central bank, BCRA, has none.

Credibility problem

Having suffered several episodes of hyperinflation and maxi-devaluations, it is natural that the BCRA suffers from a credibility problem. However, other countries have similar legacies, but they have regained their population’s trust. Yet, President Mauricio Macri went through three central bank presidents during his four years in office, and President-elect Alberto Fernández has promised to fire Guido Sandleris as soon as he takes office on December 10.

Furthermore, this is a country with a consistent fiscal deficit, which only fans the inflationary fire. Therefore, the fact that Argentine households run for the door as soon as they can is very rational behaviour.

The problem is that it was the IMF that claimed the heads of Macri’s central bank presidents, despite knowing that credibility was an essential element in stabilising the currency. This is a lesson that has been learnt throughout the region. During the past 20 years, Mexico and Colombia had three central bank presidents, Chile and Brazil had six, while Argentina had 12.

The key to economic stability in Argentina is trust. The government needs to increase the independence of the central bank and to introduce a nominal anchor to engender enough trust to temper the public’s expectations about its currency. This is something that should not come as any surprise to the well-trained crowd at the IMF.

Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.wmolano@bcpsecurities.com