Limited Prices, Limited Improvement

Feel like doing a good deed? Try sending Argentine President Cristina Fernandez de Kirchner a copy of Milton Friedman's The Counter-Revolution in Monetary Theory. She clearly needs a lesson in what causes inflation.

At least, her policies suggest she does: Her government has ordered the nation's largest supermarkets to freeze prices for two months to prevent runaway increases. Though official statistics peg Argentine inflation at around 11%, most independent observers believe it's closer to 26%, and they expect it to breach 30% in 2013.

Not that Fernandez is acknowledging these unofficial inflation metrics—she never has, aside from her occasional attempt to send the statisticians behind them to jail for endangering national security. Now, however, the IMF is threatening to expel Argentina if it doesn't adopt a more transparent and accurate inflation calculation by September 29. To avoid that embarrassing (and, should Argentina need international assistance again, costly) fate, Fernandez says she'll comply. Hence, it seems she's scrambling to make sure she doesn't have to report 30% inflation this autumn. (Huge protests over rising prices in Buenos Aires likely also provide some motivation.)

Problem is, her methods won't work. High grocery prices don't cause inflation. Rather, they're a symptom of the cost pressures brought by Argentina's monetary policy. And a short-term ceiling will only fuel market distortions and, likely, make life that much worse for Argentina's beleaguered foreign retailers.

To understand why Argentina's in this situation, we need a brief history lesson. In 2001, the nation defaulted, and it’s been largely shut out of international markets since--foreign investors took a large haircut back then, and the hostile treatment they've received ever since is a remarkable deterrent. So the government relies on domestic investors to foot its large social spending bills—it prints pesos like crazy, and the banks use the new money to buy Argentine debt. Most of which, incidentally, is inflation-linked, hence the desire to keep the official inflation rate as low as possible.

With the money supply high and rising—and the new money actually circulating, thanks to high government spending—there's a lot of money chasing a limited amount of goods. This is pushing up prices at all levels of the supply chain--higher grocery prices are simply the most visible outcome and the one consumers care about. But freezing them for two months will bring little if any relief.

Imagine you own a business, and your costs are going up, but the government won't let you raise prices for two months. You'll likely do whatever is necessary to protect your profits. Maybe you'll operate as usual and then jack up prices once the ceiling's gone. That could be a risky bet though, considering the government could very well extend the ceiling, putting you in a tight spot. So more likely, you'd do your best to limit costs, mainly by restocking goods slowly or not at all. And if business conditions don't improve, you'll likely close shop.

Thus, food shortages could (and most probably will) result from Fernandez's price freeze—likely not the outcome she wants, considering the political costs. The black market would likely fill some of the shortfall, but prices here will likely rise as market forces dictate—potentially more than they would have at the supermarkets, since black market vendors typically don't have large grocers' economies of scale. This could very well exacerbate the problem Fernandez aims to solve. Even worse, if foreign grocers (the primary targets of the ceiling) were to leave the country, Argentina would lose an important source of foreign capital, likely forcing the government to redouble its troubling monetary and fiscal policies.

In my view, if Argentina really wanted to control inflation, the government would address the issues causing prices to rise. Credible fiscal and monetary policy would be a good start, as would lifting import restrictions that artificially limit supply of certain goods. Improving infrastructure—like, for example, clearing trucking bottlenecks—would also help reduce transport costs. And making it overall easier for firms—especially foreign firms—to operate (i.e., reducing government intervention) would help goods flow much more freely and, likely, cheaply.

At the moment, however, that seems a pipe dream—Fernandez seems bent on blaming the IMF and international community for her country's woes and has no plans to change policy. Until she changes course or Argentinians pick a new leader with better plans, things seem unlikely to improve materially.