Wednesday, March 25, 2015

When $100 gets you a sandwich and a Coke

The amount of currency in circulation in Argentina is just over $300 billion pesos, and it is comprised almost entirely of six different denominations of bills, as show above (coins are essentially worthless and hardly ever seen). According to the Argentine Central Bank, about two-thirds of all the currency in circulation is of the $100 peso variety, with the other third spread between the five smaller denominations. If my experience here is any guide, it is rare to see a $2 bill, and the occasional $5 bill is, in practice, the smallest denomination that most people are able or likely to use. Ironically, the smallest denominations are the hardest to come by, and when you do see them they are so frayed and flimsy that many of them are held together by scotch tape.

To put this in perspective, $100 pesos today is worth about $8 dollars (US) on the black market, and about $11 dollars at the "official" rate. Imagine how it would be if consumers in the U.S. were limited to buying things in increments of 40 cents ($5 pesos), and if the largest bill available were worth less than $10. My friend (the one whose daughter got married yesterday) today told me that in order to pay for the wedding and all the people involved, he had to disburse an amount of bills (most things are still paid for in cash here) that would fill almost two shoeboxes. It's become almost comical, and reminiscent of the stories of hyperinflation we have all heard when people had to use wheelbarrows to carry enough currency to pay for daily expenses.

Why are things so crazy? For one, it's the inevitable result of a classical monetary inflation. But it's also because the government doesn't want to officially recognize that inflation has been running at 25-30% for the past six years—printing larger denomination bills would be equivalent to legitimizing all that inflation. That's silly, of course, since you can't cover up an inflation that is fundamentally driven by an almost 30% annual increase in pesos in circulation (see chart above) over the past six years by printing tons of small-denomination bills. Prices are going up at a significant pace, and it doesn't matter what denomination the bills have.

In an attempt to remedy this idiocy, an opposition politician recently proposed a law that would create bills of $500 and $1000 pesos. The government will certainly oppose this measure, but eventually it will pass in some form or other because otherwise the average citizen will need a huge wad of currency in his or her pocket just to make it through the day. Meanwhile, a $100 peso note will buy you a sandwich and maybe a Coke.

For us Americans it's not so bad, since $100 pesos will also get you a decent bottle of wine in most restaurants, or even a decent steak. And despite the inflation, Argentines are wonderfully nice people and the food is terrific.

The Reluctant Recovery continues

Back in October, 2012, I gave a presentation to the Economic Club of Sheboygan titled "The Reluctant Recovery." Almost 2 ½ years later I can reread my comments and conclusions about the presentation and not find much to fault or change. This says it all, and it is a mantra I have repeated continously ever since: "although this is the weakest recovery in generations, with a few exceptions the economy has undergone some significant adjustments and is continuing to expand, although growth is likely to continue to be rather slow and disappointing until and unless we get significant improvement in fiscal and monetary policy." Further, "the recovery has been a reluctant one, because the market has from the very beginning been reluctant to embrace the notion that the recovery was real and durable, much less robust. There are plenty of good reasons for the market to be concerned, of course: unprecedented changes in monetary policy, misguided fiscal stimulus, the deep-seated problems in the Eurozone, the housing disaster, and the huge federal deficit, among others. The fundamentals have improved, but market sentiment remains pessimistic. This creates an interesting environment for investors, since it means that the bar for economic performance has been set very low: the economy only needs to avoid a recession for markets to react positively."

The chart above perfectly summarizes the problem that has persisted for the past 6 years: disappointingly slow growth. The economy is 10% or more below where it could have been if this had been a "normal" recovery. We are missing out on almost $2 trillion per year in annual income, and that's not insignificant.

Although the same themes of "reluctant recovery" apply today, valuations have improved and so stocks are not as cheap as they used to be. This has led to repeated bouts of angst that the market has struggled to overcome: "climbing walls of worry" has been a theme since last October.

This morning's Capital Goods Orders was weaker than expected, but it fits within the theme of "reluctant recovery." One reason the recovery has been disappointingly slow is that businesses have been reluctant to invest, even as corporate profits have reached record levels. Investment might be a lot stronger if we cut or—better yet—eliminated the corporate tax rate. That it is manifestly too high can be seen in the roughly $2 trillion in corporate profits that have not been repatriated.

A few days ago the Fed released its estimates of household financial burdens as of the end of last year. Households have undergone some significant deleveraging since prior to the Great Recession, but on the margin not much has changed for the past few years. I think this is a sign that caution still reigns; people are reluctant to go on a borrowing binge, preferring instead to accumulate savings and keep their powder dry. It's a time of prudence. Nobody is taking outsized risks these days. "Once burned, twice shy" is still an apt description of the mood of risk-takers.

But all of this is not a reason to be pessimistic. On the contrary, it's a reason to remain optimistic. There is still a tremendous amount of untapped potential out there, if only policies could move in a more favorable direction. Policies need to be designed so that they increase the after-tax rewards to working and investing and taking risk. It's that simple: we need to cut marginal tax rates on income and investment. Moreover, we need to continue the favorable trend in fiscal policy that has prevailed for most of the past six years: federal spending needs to grow at a rate slower than nominal GDP, so that the burden of spending (which as Milton Friedman taught us is really the burden of taxation, since all spending must eventually be repaid by taxation) continues to fall. One other important reason for why this has been a reluctant recovery is that government tax and regulatory burdens have been exceedingly high. Things are improving on the margin, as federal spending declines as a share of GDP, but we've got to slash the size of the Federal Register. Starting and running a business is simply too difficult these days. I should know, since I would face a marginal tax rate of 65% or so if I decided to charge money for viewing this website. Readers will be happy to know that I prefer to work for free rather than give the government two-thirds of the fruits of my labor.

Thursday, March 19, 2015

Off to Argentina

We're leaving shortly for Argentina to attend the wedding next week of our best friends' daughter. It should be a blast, as most weddings are in Tucuman. Blogging will be light for the next several days, but I should have some time later to get back in touch with the markets. With an important presidential election looming later this year, I'll be interested to see what's happening on the political scene.