[Read my full academic thesis HERE]
Buenos Aires, Argentina
Argentina has been in serious decline in recent years. The Economist has outlined the bulk of its problems in “The Parable of Argentina,” and in general economists have taken up a morbid fascination with their runaway inflation, which has continued to worsen since the 2001 crisis.
In today’s Argentina, inflation isn’t just bad—it’s epidemic, at an estimated 25-30% annually.
The following video sums up the recent history:
For a long time, the most common savings maneuver in Argentina has been to buy dollars. Weary of their country’s banking system, some Argentines stuff those dollars in their mattresses or freezer boxes, while others simply sent them out of the country. This practice was personally helpful, but it drained Argentina’s foreign exchange reserves. In 2011, Argentines took 21.5 Billion USD out of the country, or over one third of reserves. To staunch this alarming flow of dollars out of the country, the government introduced a new system that required the Tax Agency’s permission to buy foreign currency…Argentines refer to it as “The Clamp.” The crackdown has led to the flourishing of an informal currency market called the “Blue market.” The exchange rate is much pricier than the official exchange rate, sometimes by as much as 70%, but to many argentines it is worth it. Buying dollars, however expensive, affords them piece of mind.
Long economic story made short: everybody wants dollars. And most Argentines turn to the black market to prevent their nest egg from becoming worthless with high inflation. Oh, and the government really does not like this because it dilutes their monetary policy power.
Consequently, the price of the Dólar Blue—the black market dollar—is on everyone’s mind. Hawkers on Florida Street openly solicit their “conversion services” with complete openness. Daily newspapers like La Nacion and El Cronista publish the price in the newspaper.
The ubiquity, along with the apparent lack of enforcement, is striking. In Argentina, the U.S. dollar is king.
Dollars are seemingly accepted everywhere: my landlord prefers the rent paid in dollars, and my office secretary “knows a guy” who makes house calls to convert cash. To take advantage of the wide-open black market, I came to Argentina with all the money I needed for 3 months (it was a strange rush to go through the airport with thousands of dollars like Jackie Brown). Argentines are willing to pay a hefty premium for low-inflation currency, so it’s foreigners who really benefit.
After a while I got wondering. What causes the change in the daily price? Obviously, there’s a little supply and demand for dollars—the price of the USD to Euro, I knew, changes value all the time. One day in Argentina, however, I noticed the price of the Dolar Blue jumped up significantly right before the local Buenos Aires elections. This piqued my interest: politics must play a big role in the price. It would stand to reason that people, collectively fearing a candidate who would further tighten the “clamp” on the black market, somehow spiked the demand for illegal foreign currency.
I kept thinking about it:
Could it be that the people’s confidence in government directly impacts the prices?
Could it be that, in an economy where the average person is a participant in the black market, the determinants of the premium are driven by psychological factors such as government perception?
A few months later, back at Hamilton College for my senior fall, I decided to find out empirically.
For my senior thesis in Public Policy, I decided to do a multiple regression on the Argentine black markets. With FX on everyone’s mind, Argentina’s established black market is an ideal testing ground to see if psycho-political measures like presidential approval could hold any influence on the black market price and premium.
Because Argentina’s government cooks the books on inflation (reporting 10% when it’s 25–28%), accurate data was difficult to acquire. I actually had to use State Street’s PriceStat web crawler algorithm to get accurate figures for prices. Eventually, I had all my monthly data going back to 2010 predating the black market boom.
Because of the causal problem that arises between the independent variable of interest and the dependent variables—the Black Market Premium could be a reaction of the political circumstances and vice-versa—a two-stage least squares (TSLS) approach was used in the regression. All this means is I had to plug in my estimate of presidential approval using everything BUT the actual approval ratings.
Black Market Premium = c0 + c1 pres pop.hat (p̂)+ c2 dollar/euro exchange rate +c3 currency regulation + c4 money supply + u
I predicted that the Black Market Premium (percentage difference between the official and black market price) would be correlated with presidential approval, in tandem with traditional economic factors such as M1, USD/Euro, and Currency Regulations.
My regression results:
[Rsquare = .915]
From my Two Stage Least Squares analysis results, I found that Presidential approval is significantly correlated (negatively) with the Black Market Premium, confirming my hypothesis. It makes sense that the premium for illegal money would be higher during periods of low government approval, because of the government’s trend to make it harder and harder for citizens to acquire currency (via capital controls).
Also unsurprisingly, M1, the amount of Argentine money supply (total pesos in circulation), was significantly correlated positively. This also stands to reason because money supply is generally regarded as a harbinger of inflation. The market, according to the data, reacts to Argentina’s over-printing of currency, and, in turn, upping the price because of the soon-to-come inflation. So a positive change in Peso supply will positively increase the premium for an Argentine to buy black market dollars.
So what does this all mean?
In short, I proved that perception is reality. Since the average person in Argentina is a black market participant, perceptions do matter and are reflected in the black market price.
When one reads El Cronista in the morning and sees an article that the government is manipulating the currency volume, or making it harder to access dollars via capital controls, people rationally respond and demand more low-inflation currency before it’s too late. Thus, the going rate for the Dólar Blue becomes a few centavos (and sometimes whole pesos) higher. It’s simple supply and demand in an efficient, albeit black, market.
Since the black market for FX is highly developed in Argentina, this study and related research could become rules of thumb that people use when making the decision of converting their savings to avoid inflation. The implications for this study are powerful because both of these measures are figures that the average Argentine might see published in a newspaper; the measure of M1 is always part of the political fray, as are new laws for currency restrictions. In essence, the study highlights that the average person (or savvy trader) shouldn’t just read the Business section, but also the political news.
TL;DR—When it comes to black markets, perceptions do matter.
[If you liked this, check out my full thesis HERE]