Work Abroad but earn in USD

Tuesday, May 09, 2006

The Undervalued Peso

I received a question today about the rumors of the peso being undervalued. Although I've addressed this issue in other posts, I wanted to make a very detailed explanation so that expats can understand what the issues are. The currency issue is an important one for every expat that's living here on a U.S. dollar-based income or pension.

Reader's Question

I keep hearing that the peso is undervalued and that the government is deliberately keeping the exchange rate with the dollar low. Is this true? And if so, how and why are they doing it? I thought now that the 1:1 fixed rate days were over the market is free.

The Peso Market

The days of 1:1 are over and now we're living in the days of 3:1. However, the market is by no means a free one. It is still tightly controlled by the government. The central bank controls all wire transfers going in and out of the country. Anyone wiring money in or out must show the government what they're doing and why.

Like the government of China, the government here allows the peso to float within a certain range with the dollar. Over the last few years that range has been between 2.8 and 3.1. However, many people here believe the true market rate of the peso is between 1.8 and 2.4. So, how does the government keep the peso down, why are they doing it, and can it continue?

Why The Peso Wants To Rise

There are several reasons the peso should be higher these days. First is due to the fact that there's more exports now than imports. When you have everyone selling abroad, the exporters get paid in U.S. dollars. However, they pay their bills in pesos, so they must turn in their dollars for pesos. If you repeat this process thousands of times you'll eventually have more people who want pesos than dollars and this causes the value of the peso to increase.

In addition, there's a lot of people with dollars who are coming here. All these expatriates, foreign investors, and tourists have dollars and they need to exchange them out for pesos to pay for things here. That puts more pressure on the peso. With such a demand for the peso and only a limited supply of pesos out there in the market, the price of the peso should go up.

Market Manipulation

The government, however, is preventing the rise of the peso. It wants to protect the exporters and the national industry. It does this by buying up all the dollars on the market and printing new pesos. By buying up all these dollars and supplying pesos to everyone who wants them, the government can keep the peso from increasing in value.

This strategy does cause some problems, however. Namely, inflation. By flooding the market with all those pesos, the peso's buying power would be reduced -- too much money chasing too few goods. The government knows, this, so they are countering this by borrowing back all the pesos they've just printed. So, the number of pesos in the marketplace remains more or less the same.

Nevertheless, this strategy is not sustainable over the long term. Although the government earns some interest on the U.S. dollars it is storing up, the amount it earns is less than what it has to pay out to borrow all those pesos. Eventually the interest payments on the pesos will blow a hole in the budget and the government will be forced to let the peso rise in value.

Impact for Expatriates

What this means for you is that you can't expect to have a cheap peso forever. While I fully expect that Kirchner will keep the current exchange rate policy when he's reelected next year, if he can't get the inflation problem under control, he may be forced to let the peso rise. Inflation has been the undoing of so many other Argentine presidents, I would expect that Kirchner is more obsessed with keeping inflation low than he is keeping the exchange rate fixed at 3:1. So, just keep an eye out.

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6 Comments:

Blogger johnny said...

Thanks for the remedial economics for us dolts. It appears Argentina may go the way of Brazil, who has seen the real appreciate considerably over the past two years. I hope to see many comments on this topic. I suspect I am like many local expats, in that I talk alot about how much I like it here, BUT, if the peso rises to a significant extent, color me gone ! By the way, it would be nice if someone could post a link to a site(s) that tracks the dollar versus many currencies around the world. For example Peru, they beat Argentina badly in the seafood department, and I love seafood.

5/11/2006 08:33:00 AM  
Anonymous Anonymous said...

In response to johnny's comment; he can try the following website for currency comparisons:

http://www.xe.com/

5/11/2006 11:46:00 AM  
Blogger Ted said...

johnny,

Interesting post, but according to what I've been told in another thread on here you must be fairly unique because most expats there aren't attracted by the current exchange rate, are there solely because they like BA and are busy making their dollar-denominated fortunes there in ways that are amenable to that.

5/11/2006 08:41:00 PM  
Blogger argexpats.com said...

El Expatriado, that was an excellent summary of the situation and pretty much dead on - nice job.

I always advise people to cushion their budgets well because it could happen anytime really but probably later than sooner.

To Ted,it would be absurd to think that "most expats" are here for the glory alone. The exchange rate has a pretty big part to do with it. Once things even out in the quarters and years to come, a decent percentage of foreigners will scatter like flies, leaving the true lovers of this country until the next cycle hits. I specifically used this exchange rate/pricing period to fairly easy make my latest move here and am committed to trying it for the longer haul this time since certain criteria and market conditions are looking good for the future in my opinion.

5/11/2006 10:44:00 PM  
Blogger johnny said...

Hey Ted,

Well, don't get me wrong, I do like BA. There is alot to like, but if the rate got to 2:1 or thereabouts, BA would not be as attractive (at least to me). My guess is, if that were to happen, some of the "romance" of BA living would begin to wane a bit for others as well. HOWEVER, I would think hard before leaving, and were I to do so, I would not be heading back to the states. Though I might go back in November to have a beer or two after the midterm elections !

5/11/2006 11:07:00 PM  
Blogger apartmentsba.com said...

Good post as usual EE. I agree with you. I do think that Argentina will stay in a good trading range for the near-term. I publicly called the exchange in 2003 staying between 2.75 - 3.25 which was absolutely spot on. In fact, when it went to 3.8 I took a big chunck of my savings and bought pesos and sold them back at 2.85 - 2.95 when I moved here.

People asked me how I knew it would stay in that range. I thought about the export situation and how vital it was for Argentina. I think another reason the government has an incentive to keep the peso from rising too fast is also tourism implications.

Tourism is one of the most important and biggest money generators for Argentina now. With a currency too strong...the numbers won't go up like it has been. Tourism is a u$s 3.5 BILLION a year industry for Argentina now.

You have to factor in all of these things. Exports are so very important. The days of 1:1 are gone forever NEVER to return again.

Do I think it will stay at 3:1 forever? Nope... I agree that many are here because of the cheap cost of living. Most if the peso stregthened will be moving back to USA, UK, Europe, Australia and other home countries.

There are VERY few ex-pats making u$s dollars. I did NOT move to Argentina to get rich. I moved for the lifestyle and the city but still I knew I had to make u$s dollars or I wouldn't sustain for the long-haul here.

A very very very small percentage can live here indefinitely and have a really high end lifestyle here unless they are making u$s, Euros or Sterling.

I'll probably always live in Argentina no matter what happens. I really love the city. Inflation is a problem to deal with....we'll see what happens...

Cheers all.

5/13/2006 12:14:00 PM  

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