All is not well down-under, and by down under we do not mean Australia, but a country that could have been pretty similar; Argentina. It has a couple of pretty unique problems that are quite interesting.

We came across a book that argued that Argentina had all the opportunities to develop like Australia. And indeed, going back in history, not many will remember that at the beginnings of the last century, the country was actually one of the five richest in the world.

The country actually has a lot going for it. It’s the first, and probably the only successful multi-cultural country in the world, and that’s no mean achievement now that the whole concept of multi-culturalism is both on the rise as a result of globalization and under threat as, how shall we put it, not everybody is happy with it’s consequences.

The backlash against multi-culturalism that is so prominent in many European countries seems largely absent here, apart from the odd remark about Bolivians one sometime encounters. Something of this relative success has no doubt to do with the fact that most immigrants have been European, which put an upward limit on their diversity.

The two biggest groups of  immigrants are Italian and Spanish, and although they do have their differences (try to get a drink after 11pm in a small Italian town, and then try to do the same in a Spanish equivalent and you will find out), these are not as big as the Moroccans and the native Dutch, or the French and the Algerians, say.

Like Australia, Argentina is vast, with lots of empty space and fertile lands. It’s extremely well placed to profit big time from the soft commodities (agricultural products) boom that has been going on for some time. It’s famous for it’s excellent meat (Argentinians eat 1.5 times as much per head as the carnivorious Americans).

There is a conflict at present going on between the country side and the government of Kirchner (the wife of the last president), a left leaning populist, that has imposed tax increases on the export of a few of these soft commodities, most notably soybeans.

While this conflict has the country on its feet, another problem hardly gets mentioned, which we find very odd. Argentina suffers from runaway inflation (25-30%), as one of us (who lived there for a while, recently) can tell from experience.

You go to a supermarket, and stuff you bought last week for 8 pesos is suddenly 12 pesos the next day. And nobody seems to complain about that. Inflation is particularly hard for the poor, which is a conundrum, as the present government is supposed to represent them (this is also their main argument in the conflict with the countryside).

But not all poor are equal. Some poor workers have unions, and they are able to get rather spectacular wage increases. It’s the organized urban poor who are the mainstay of the present government, the unorganized poor suffer, in silence.

Now, the two problems we were referring to in the title are the following:

1. Inflation is not even measured properly, the official figures (in which inflation still runs in the single digits) are a travesty, and worse, they are an official travesty
2. Even if inflation would be measured properly, the central bank is ill equiped to deal with it, and the government won’t.

Let’s discuss these. The offical inflation figures are fiddled, and in a very creative way. One way is to ‘adjust’ the price index for goods and services that have increased rapidly in price. They are removed from the index on the grounds that they’ve become so expensive that Argentinians would not buy them anymore, so why keep them in the index. We’re not kidding.

If inflation is not measured properly it creates serious economic problems. The Hayek article we talked about today in another article also expounds the use of prices as information signals, driving distributed decisions.

If these price signals get distorted, the market does not work on the right information anymore. An example will illustrate. If you see prices of your inputs rise, that could very well affect your production plans, but if the price rises is not caused by an increase in scarcity of that input, but just general inflation, than you might very well arrive at the wrong conclusion.

These problems get especially serious where the future weighs more heavily, investment decisions run a big risk in getting seriously distorted. If the fog of the future gets a lot thicker because it’s that much more difficult to distinguish between general inflation and particular price changes, it may very well affect investment in a negative way.

Investment is a leap of faith in the future, as returns need to be generated for many years from now. If that leap becomes too large to jump, people will cut back on investing. And investment is just what this country needs. This is a very serious problem which only gets a fraction of the attention it warrants.

The second problem is that even if it would be measured correctly, the Argentinian central bank is very ill adapt to deal with it. Why? because the main transmission mechanism, money creation via bank credit, is particularly weak in Argentina.

And you can’t really blame them either. In the last econmic crisis (late 2001), many Argentinians were defrauded out of their bank deposits by the government, so they don’t trust banks. Some of these effects seem comical to an outsider, like if you want to buy a house in Argentina, you have to pay in cash, literally.

But it’s not comical, really. It means that an interest rate hike by the central bank would hardly work. It wouldn’t stop much bank lending, because not much bank lending is going on, and bank lending is the main way of money creation in an economy.

In fact the little bank lending that is going on is mostly directed towards productive investment, so in time, higher interest rates would be counterproductive, leading to smaller production capacity and hence the same amount of money chasing fewer amounts of goods.

The main alternative of the central bank in combatting inflation is to let the peso appreciate, and that is exactly what they’re doing (in a rather modest and politicized way, but still). But this erodes competitiveness twice, once via higher prices, and then again by a higher peso.

Argentina has so much to offer, all that potential created by a creative clash of cultures remains largely that, a potential. They have been fooled by their politicians for too long.