Milei Is For Real
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*Not financial advice, merely pointing out political trends*
This is an expanded version of a section of our December 2023 Monthly.
Milei and team introducing the DNU reforms
Argentina’s new President, Javier Milei, took office on December 10th. In the weeks leading up to this inauguration, people speculated what his first moves would be (we of course knew very well and told you what would happen). Would he be able to work with Congress? Was he serious about all of his mega campaign promises? Would he actually be able to defuse the peso and banking sector ticking time bombs?
Well, after three weeks, the answers are pretty clear: Milei is for real! Far from just repeating libertarian economic talking points, he has begun the world’s first real time libertarian lab experiment. The outlook is quite promising for his political prospects and for the country’s economy. The right in Argentina had identified that the gradualism other center-right presidents in the past practiced did not work. This time, they needed to do major reform starting on day one.
Investors clearly love the program. Starting from the day before Milei’s win, Argentine bonds have nearly doubled. Key stocks like YPF and Banco Galicia are up 60-80%.
YPF Six Month Chart
Starting The Chainsaw
Milei has done a breathtaking amount of reform in just two weeks, taking his promised chainsaw to government spending. A review of the spending and program cuts announced thus far:
· Cutting the number of ministries from 18 to 9
· Firing roughly a third of secretaries, sub-secretaries, and ministers
· Suspending all new programs and public works
· Elimination of subsidies for energy, electricity and innumerable state owned enterprises
· State workers’ wages had been growing above inflation for years under Kirchners, now he is having government employees’ salaries grow well below inflation
· Terminating 7,000 government employees’ contracts, with another 45,000 under review
· Innumerable little spending cuts and eliminations of public waste
Projections now indicate that the government deficit should go from a deficit of 6% of GDP in 2023 to a balanced budget or a small surplus next year. Our favorite anecdote is the catering company that was billing the President’s office for 1600 ham and cheese sandwiches per day- but only delivering 200 and pocketing the difference. The contract has been renegotiated.
At the same time, Milei has managed to liberalize the exchange rate regime. Argentina has multiple exchange rates and regimes for converting pesos to dollars. The day of the election, the ‘official’ rate was 350 pesos to the dollars, versus a 1,000 informal rate. This represented a windfall to politicians and their friends who could access the official window, and then arbitrage it with the unofficial rate, as you could essentially triple your peso balance. The different exchange rate regimes for importers and exporters are going to be eliminated. Under Milei, the exchange rate gap has already narrowed to an official rate of 850 versus a 950 unofficial, and it should fully merge in 2024. Milei’s reforms also now allow people to contract in the currency of their choice (pesos, dollars, bitcoin, yuan etc) which will likely lead to the withering away of the peso, to be replaced by stronger currencies. This will, coupled with the shrinking money supply and structural reforms, cause inflation to crash in Milei’s first two years. We wouldn’t be surprised if Argentina enters a deflationary period as competition picks up in every industry.
Fixing The Exchange Rate
The central bank has managed to build $2bn of reserves in the first two weeks, and at this pace, should have than enough dollars to handle the international payments due in 2024. The central bank also stopped printing money and ran down all of the LELIQs (central bank notes) that the government had stuffed for years into banks to finance itself. A major obstacle to banking stability and dollarization is gone in a week, whereas we were worried it would require months.
The informal dollar peso rate, “the blue dollar”, which had started the year at 350 reached almost 1000 by the first round of the election. Since then, it has held steady as Milei won and then began his term by shrinking the pesos in circulation. We expect it will hold around here, eventually merging with the official rate. The government is targeting a 2% depreciation per month.
Blue Dollar Rate in 2023
The government has also ended the special privileges of Banco Nacion, the state owned largest private bank, and opened up the marketplace to competition. One aspect of this is restoring depositors’ ability to buy dollars and keep dollar accounts in Argentina. This will slowly see more Argentines keep more assets in the country rather than offshore, and will help restore exchange rate stability.
Most of our readers live in countries with open capital accounts and mostly steady exchange rates, so one has to imagine the alternative. For nearly all of the past 22 years, Argentines have not had that privilege. The return of the ability to freely bring money into and out of the country, and to have a low inflation environment with a steady currency is a blessing for everyone. Instead of trying to quickly turnover one’s pesos in a game of hot potato, now one can engage in saving that is renumerated and perform long term economic planning. One can accumulate capital and allocate it with a reasonable idea of returns.
Shock Therapy and the DNU
All of these reforms would be impressive under any government. All of these reforms, in just two weeks, is very impressive. But perhaps the most impressive part of this is his massive structural reform package called the DNU. It’s a decree now, but the Congress and Senate have indicated they will not block it, so it will become law after 90 days.
This shock therapy will completely unshackle the private sector from its decades long stagnation. For context, one must understand that almost every industry in Argentina exists with a phalanx of anti-competitive rules that protect it. This system rolls on because 40% of the country gets a handout. Those people, along with the union members and government employees who get special benefits, constitute a majority who kept voting for this. ntil Milei. Politically connected businessmen work hand in with a very corrupt political class for special contracts and benefits, and to keep out new competition. The average person gets screwed with the resulting high prices, high taxes, high inflation, and poor real wage and productivity growth. The caste perpetuates itself.
One big rule is the ‘buy Argentina’ rule that exists for industrial products. If the product is made domestically, anything from concrete to steel to ball bearings, you have to buy from an Argentine supplier. Even if the German steel is 10x better or the Brazilian version is one third the price, you don’t have the choice. This especially hurts businesses in border towns, who could buy cheaply from across the river in Uruguay but instead have to truck something from hundreds of miles away in Argentina. This has kept a host of inefficient companies in business- and their union laborers voting Peronist. But it hampers the rest of the country.
On an individual industry level, there are a host of regulations that thwart competitors entering the market. Supermarkets have a dizzying array of price controls and advertising requirements impossible for small groups to keep up with. Monopoly grants exist on a host of assets and industries, like electricity and tourism agencies- yes, each province has a state-owned monopoly tourism agency which contracts with its best buddies. Banking is regulated to an enormous degree, so that there are essentially five major national banks and no foreign competitors. Fees are high, service is trash, and there is very little lending to the private sector. Magically, senior politicians end up on these boards after their time in office.
Now, all of the little cliques, mafias, and politically connected companies that dominate Argentine industry are vulnerable to disruption. This will create massive growth in almost every major industry from supermarkets to energy to Internet to wine. The expansion of the supply side is going to cause increased productivity and likely even a period of deflation for the country. We think that the increased investment from the private sector will likely offset the rapid tightening of monetary and fiscal conditions.
We won’t list the 30 full points of his DNU, you can read them here (in English). But to see how much this will improve outcomes for everyone, let’s look at the airline sector as an example. First, the government has been subsidizing losses at state owned Aerolineas Argentinas for years- $8bn in the past fifteen years. That will end. Its ownership has been transferred to the employees, who now will be responsible for management and for making it competitive, and will eliminate possible political interference. The government has ended the company’s monopoly on flights within Argentina, and is allowing foreign airlines to enter the market and operate . Previously, any company operating within Argentina was required to have majority Argentine ownership. Cargo transport will be open to any operator now, giving consumers more choices. Restrictions on flights into and out of Argentina to foreign countries are lifted, so that tourists and business travelers will have more options. Price controls and fees that were in place, and led to very high ticket prices relative to its neighbors, will be eliminated. As airports are already mostly privatized in Argentina, they will be able to expand capacity to meet this coming wave of demand. Expect this whole new policy to lead to a boom in foreign travel and a shift away from the long bus rides between cities that Argentines currently endure.
And this is just one industry folks. As we said, similar sweeping reforms at the industry level have been enacted in nearly every industry, including very important ones like energy, banking, and agriculture. Reforms of the major anti-business laws that impact all businesses, like Argentine’s very hostile labor laws, are an additional boost. Two important examples: Argentines will be able to work for the first time as independent contractors, and union workers who blockade can be terminated.
Privatizations
Lastly, Milei has announced an agenda to privatize (story in Spanish) all the state owned assets he can. Right now, that is a list of 33 companies employing 100,000 people. This agenda will contribute to easing the fiscal burden and improving the country’s overall productivity in sectors like post and packages, trains, cargo, etc. Some of these are going to take a long time to fix- the train company for example spends 10x its current revenue. Argentina’s Mendoza to Buenos Aires train currently takes eleven hours longer than it did when it first opened – in 1895! To say that this will take the future buyers time to turn around is an understatement. But at the same time, if Argentina eventually moves these sectors up to regional or international standards, the gains will be enormous.
We understand that sometimes, privatization agendas can go completely off the rails- Russia in the 1990’s, where everything ended up in the hands of a few oligarchs. There is always that risk. We think that these may work out however. Milei does have business links, specifically to his former boss Eduardo Erkenian, a billionaire with energy and airport assets in the country. But there seems to be no indication that Milei would treat him much differently and just hand off the state’s crown jewels. Our discussions with now members of the government have indicated that they want to put together a commission or committee, similar to the one that was formed in Spain, to evaluate offers, proposals, and potential buyers for state owned assets in a transparent manner. They would also potentially merge national government owned assets with provincial ones in order to gain scale.
On the acquisition side, our sources in Washington have told us an interesting additional point. The US government now sees it as a major strategic priority to have American and America-friendly businesses invest in these privatizations. The government in DC is very interested to keep the Chinese and their allies away from key infrastructure like railroads or ports. This means that the Argentine government will have a lot of ready American buyers, likely with US government funding and support, lining up to take these assets off its hands.
Political Considerations
Polls show strong support for this agenda is over 70%. That will give Milei a tailwind for the near term and a cushion for when austerity comes. If reforms succeed in lowering inflation significantly, then he could ride 70-80% approvals by the time the midterms roll around in two years and expand his presence in Congress.
There is a larger agenda at play too. As we mentioned earlier, the Peronist system depends on a cozy relationship between union leaders, connected businessmen and the political class. Milei’s labor reforms will lead to a weakening of unions and union funds over time. The opening up of many industries will increase competition and decrease the opportunity for cozy relations between politics and business. With fewer ministries, fewer government contracts, and fewer officials, there is less patronage to dole out. All these changes will lead to a weakening and eventual breakage of the Peronist system’s key links. Fixing the economic system will lead to a more competitive and more open political system in time. And once the average voter in future years realizes that Milei was right and the system actually was rigged, Argentina will have a new market friendly political center for a generation.
It’s Boom Time!
Milei has proven he is for real, readers. And we still have four more years of reforms coming! Milei could end up being one of the few world leaders able to rip out socialism before a country’s total economic and political collapse. Do not underestimate how major this shift is. Decades of monetary chaos and low productivity are now turning into what will be one or two decades of private sector growth, investment, competition and price stability. This has rarely been seen in economic history, with perhaps the reforms of Eastern Europe in the 1990s and Thatcher’s Britain of the 1980’s being the best comparisons. The Czech Republic, as an example, went from having a GDP per capita of $2,000 in the early 1990s to $27,000 currently. But even if Argentina’s economy ‘only’ performs as well as Brazil after the Plano Real, or Mexico post-1994, it will still represent a sea change for investors and business owners. Book a (soon to be more numerous) flight to Buenos Aires before everyone else does and start to identify the best opportunities. As an Indian CEO once told us: “No no no, you don’t understand, it’s boom time!”
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