La Nacion – The the economic team officials can not explain what is the reason why the dollar escapes and inflation subsists after having met the objective of not increasing the monetary base. Moreover, monthly inflation is growing.
The reason for this apparent paradox should not be sought in monopolistic maneuvers or in cunning supermarket owners. Nor does this situation invalidate the theory that indicates that, with some exceptions, inflation originates in the spurious creation of currency. This is what reality has shown, without occasionally excluding other factors.
Current Argentine inflation shows, for example, inertial components and the impact of tariff recoveries. But the most important cause and that very few mention is the increase in the velocity of circulation. This phenomenon is known in economic jargon as the “falling demand for money”. This behavior began during the government of Cristina Kirchner and continues, without President Mauricio Macri having been able to reverse it.
The quantitative theory of money is based on the Fisher equation: p.q = m.v. It says that the average level of prices “p” multiplied by the quantity “q” of goods and services traded in the economy is equal to the amount of money “m” of the system multiplied by its speed of circulation “v”. Naturally, we refer to the local currency, that is, to the pesos. Usually the economic analysis considered that the velocity “v” does not have significant variations. Therefore, it is said that if the activity level “q” remains constant, it would be the variation of the quantity of money “m” which would determine the variation of the average price level. In stable countries, it is like that, but not in those that are not. Argentina is one of them.
The speed of circulation of money stopped being constant and increases when distrust in the value of the currency grows. It is a collective phenomenon that does not depend on a few operators or bankers who are plotted, but on hundreds of thousands of individuals who accelerate the use of their pesos by transforming them more quickly into dollars or goods. A growing distrust impels them to protect themselves in this way.
Banknotes spend less time in wallets and bank deposits rotate rapidly. The speed of circulation increases and the same mass of means of payment serves to carry out more transactions or, if the production does not increase physically, what happens is that the prices increase. A doubling of the speed of circulation of money has the same inflationary effect as a doubling of the money supply.
Who deepened the analysis of this question was the American economist Philip Cagan, who in 1956 published The Monetary Dynamics of Hyperinflation. It was a widely disseminated document that studied the self-feeding of inflation due to the effect of the flight of money. This phenomenon, which became evident in our country in both 1975 and 1989, is analyzed in The hyperinflation of 1989 (Manuel A. Solanet, Editorial Lumiere, 2006).
Not demanding the currency is a phenomenon that obeys to collective behaviors that falls in the field of mass psychology. Its overcoming requires a change in the collective perception that results from some new and forceful fact.
The graph that follows, shows two different periods of our recent history, the number of days on which the M1 rotated, that is, the set of bills and coins plus current account deposits. The shorter that lapse of rotation, the greater the speed of movement. The periods plotted are 2012-2019 and 1987-1992.
In the two hyperinflationary peaks, in July 1989 and January 1990, the M1 rotated every 4.7 days. The speed of circulation had been increasing since 1987 and since the end of 1988 accelerated. The levels of inflation reached could not be explained only by the issuance of currency, but they found their arithmetical reason when the increase in the speed of circulation was also considered.
Since 2012, the rotation period of M1 is decreasing. The estimate for the 1st quarter of 2019 corroborates the trend. In the last 12 months the speed of circulation grew 44%. Undoubtedly, here is a large part of the explanation of current inflation. The fall of confidence is what fuels the phenomenon. The motivation for this fall is not only the perception of a weak economic situation, but an important political component. It is the growth, according to the polls, of the electoral chances of the former president.
The flight of money can lead at its extreme to hyperinflation. It is when the merchants stop selling and the manufacturers stop producing, because they do not have the security of being able to replace the merchandise, due to the vertiginous increase in prices. It is not likely that this can happen to us again.
Unlike 1989, today the level of reserves is still sufficient to respond to the entire monetary base and President Macri has extensive external support. But he should not delay or wait for his reelection to generate forceful facts that reverse economic pessimism and increase, at the same time, his electoral possibilities. Those who take care of the value of their savings, as well as specialized analysts, know that it is not with price control or with artificial breaths that the value of the peso will be preserved. This is shown by the increase in country risk after the measures were know announced on April 17. The recovery of trust requires urgent structural reforms that ensure a reduction in public spending, a fiscal balance horizon with lower tax pressure, labor competitiveness and trade opening to the world.
By: Manuel A. Solanet
Director of Public Policies of the Libertad y Progreso Foundation