The country was broke when Javier Milei took office in December 2023 as President of Argentina. He came to office with the support of more than 56 percent of voters, offering a libertarian vision of economic policy embodied in the promise of dollarizing the economy, something the majority of voters understood and appreciated.

　　Dollarization, however, was not the path taken by Milei’s administration, at least not yet. Instead, Milei appointed Luis Caputo as his finance minister, a mainstream economist, former trader, and central banker who has implemented a very orthodox economic plan centered on rigid fiscal austerity and stringent quantitative monetary control.

　　That surprised many who perceive Milei as an economist influenced by the Austrian School of Economics. Competition in currencies and economic liberalization are, respectively, the monetary arrangement and the economic policy preferred by most Austrian economists today.

　　In our view, political and economic (both practical and theoretical) reasons determine President Mileis choices, and we will argue that an economic approach first proposed by the French economist Jacques Rueff helps more than other theoretical frameworks to explain his choices.

　　A Daunting Challenge

　　It is important not to underestimate the gravity of the problems Milei set out to tackle when he first assumed office. Annualized inflation was spiraling out of control, moving towards hyperinflation. The central bank had short-term obligations paying stratospheric interest rates amounting to three times the monetary base. On top of that, the national government was running a deficit of about five percent of the GDP. The countrys risk was above 2,500 points over US Treasuries, and it was de facto in default, with negative net reserves of foreign exchange in the central bank. Even imports had not been paid in the previous months, leading to a shortage of fuel and medications.

　　The irrationality of Argentinean economic arrangements goes well beyond that, with a completely rigid labor market and many other ills: Relative prices in complete disorder due to price controls and an overvalued currency. An inefficient public sector with a size of more than 40 percent of the GDP is exceptionally high for a medium-income society. The economy was and still is quasi-autarkical, with extremely high tariffs and all sorts of other protections to national industry on the import side, capital controls, and a tax system based on duties on agricultural exports, with other primary goods like minerals, one of the few sectors of the economy able to compete internationally.

　　The political difficulties faced by the Milei administration are likewise enormous. His coalition with a centrist party holds less than a third of the seats in the Argentinean Congress. In the judiciary, the last say belongs to a supreme court composed of politically appointed judges, and vast swaths of the bureaucracy, along with provincial and local governments, who are hostile to any attempt to change the status quo. Given those realities, the plan Milei is following surely is not the one he dreamed of implementing.

　　The bottom line is that although the immediate cause of inflation is always monetary, the ultimate cause is fiscal.

　　Nevertheless, he is trying. The proposed reforms that required legislative approval are mostly stalled in Congress, but a watered-down “Ley Bases” was approved on June 28, 2024, includingsome welcome but insufficient microeconomic reforms to attract foreign investment. Admittedly, this is difficult due to the macroeconomic uncertainty. Many of his proposals, which were the object of an “emergency decree,” were ruled unconstitutional by the courts. His administration was left with very basic and limited instruments to reform the economy: the taxation on exports, the withholding of discretionary spending by the national government, and the manipulation of exchange and interest rates by the central bank. These are truly his only tools. Like the fictional TV character MacGyver, Milei was left to disarm a nuclear time bomb with a paper clip.

　　If Milei had greater support in parliament, supply-side microeconomic reforms and privatizations could have reduced the recession resulting from the sharp reduction in discretionary spending. In the absence of that, extremely high interest rates, when measured in US dollars (as done by everyone in Argentina), and a dearth of pesos in the economy, have dramatically reduced domestic demand.

　　The first practical reality facing possible dollarization was the suppressed demand for dollars at the official parity of 400 pesos per dollar in December 2023. Since then, a devaluation to 800 pesos per dollar plus a crawling peg of 2 percent per month, which brought the official rate to 963 pesos per dollar nine months later (in September 2024), has not quenched the demand even in the middle of a total peso drought. If foreign exchange markets were to be liberalized—starting by ending the “cepo”—to allow the dollarization of the economy, the demand for pesos would be significantly reduced, and hyperinflation would remain very likely.

　　Many in Argentina are voicing concerns about Caputos economic policy. Since the devaluation in December, inflation has reduced the dollars real purchasing power. The Big Mac index collected by The Economist is the most prosaic evidence of that: In January, immediately after the devaluation, it was possible to buy a Big Mac in Argentina for 3.83 USD, while in the USA, the cost was USD 5.69, with an implicit undervaluation of 33 percent. Seven months later, in July 2024, the price of the Big Mac in Argentina in dollars rose to 6.55 USD, with an implicit overvaluation of the local currency of about 15 percent.

　　However, there is a consensus that the government’s priority is reducing inflation. The central bank is no longer funding the treasury. Since June, new pesos have not been issued even to buy foreign exchange, a stringent quantitative control. With that, inflation has plunged from 25 percent per month in December to 4 percent per month since May, despite a significant (however insufficient) recovery of some controlled prices in the economy, such as energy, telecommunications, public transportation, and the like.

　　The most benign interpretation of Caputo’s plan is that the government is betting on bringing inflation to close to zero in 2024 for the 2 percent crawling peg to start gradually devaluing the currency in 2025 before starting to liberalize capital controls. This would reenergize the export sector and the economy in time to help the government win a majority in the elections at the end of next year.

　　Suppose the government can agree with the opposition in the legislature or gain financial support from the IMF. In that case, the goal of zero inflation and a neutral exchange rate may be achieved without deflation, further reducing public spending, or crowding out private borrowers due to high interest rates and financial repression. Without that, the bitter medicine needs to be swallowed without any sugar coating.

　　Many doubt the wisdom of administering the bitter medicine of forcing real prices downward before allowing the exchange rate to float. Ludwig von Mises, in his seminar, “often likened such a process to an auto driver who had run over a person and then tried to remedy the situation by backing over the victim in reverse.”

　　A New Paradigm

　　With that, we come to the theoretical framework proposed by Jacques Rueff, which may help us explain the policies of the Milei administration. We contend that far from contradicting any lesson from Austrian economics, Rueff’s ideas may be understood as a refinement of catallactic thinking, one that considers elements usually left out of the picture.

　　During the interwar period, Rueff was a highly respected economist and civil servant in France.

　　During the Vichy government, Rueff took refuge in a small town in southern France. Despite his Jewish heritage, he was left relatively unmolested by the government of Marshal Petain, the best man in his wedding.

　　Rueff then compiled his magnum opus, “The Social Order,” with some texts he had written about static equilibrium in the 1920s and 30s, and wrote a new hypothesis about “dynamic” economic equilibrium. His dynamic approach to the economy was based on applying private property rights to explain the value of money and its central function in maintaining social order.

　　For Rueff, in regular economic activity, it is the creation of new wealth, be that goods or services, once acknowledged by the other members of society by purchasing it at a given price, which “credits” the producers of that wealth with “true rights” to dispose of whatever is available for sale in society.

　　Conversely, through the budgetary process, the state may create “false rights” by issuing debt or money beyond its capacity to service those obligations with its existing revenue stream.

　　A realistic exchange rate (the price of national money compared to the price of all other monies) and the interest rate (the price paid to have money now given our time preference) are the two most important prices in the economy.

　　Rueff sees a clear relation between the availability of goods and services on the “real” side of the economy and the creation of “true” and “false” claims over those goods on the “abstract” or “financial” side of the economy.Imbalances in that relation, caused by the introduction of “false” rights, explain inflation and other instances in which the expectations of having a credit against the government honored at a certain purchasing power are partially or totally frustrated.

　　The bottom line is that although the immediate cause of inflation is always monetary, the ultimate cause is fiscal. The government inflates the circulating media to create “false” rights over the existing goods and services, which will be used for political purposes, be that to wage war, pay pensioners, public servants, or any other beneficiary of government largess.

　　Milei uses the term “seignorage” to describe the revenue obtained by the national government from the abuses of its monetary prerogatives. However, the transference to the government of real goods by manipulating the money supply is the same as Rueff’s “false rights.”Realizing that fundamental truth led Milei and Caputo to rely on fiscal austerity to restore order in Argentina.

　　Such a framework helps to explain the folly of trying to “dollarize” the economy at an exchange rate that is not the exchange rate of “indifference” (between holding pesos or dollars). It also helps explain why, most likely, achieving an exchange rate of indifference would trigger a hyperinflationary process.

　　As in any other market, there is an “equilibrium” price for the exchange rate. Because the goods traded in this market are money, if the market operates at any exchange rate other than the rate of indifference, we observe monetary disequilibrium. Allowing the market to find the equilibrium rate would provoke a significant change in relative prices; the government would lose revenue in the short term, and expenses would increase significantly. It is doubtful that the national government could honor its obligations without printing money. Further, it is doubtful that inflationary inertia can be eliminated without a plan like the 1994 Brazilian Plano Real. Of course, we consider that “dollarization” is “competition in money” and that the Argentinean government will not stop issuing pesos. Argentina can only adopt a “dollarization” by eliminating the peso if they have the dollars to buy out all M1, if not more, which they do not. In Hong Kong, for example, the currency board has reserves of more than five times the currency in circulation.

　　Last but not least, even if hyperinflation could be avoided by a combination of high interest rates, IMF support, and financial repression, without fiscal balance it would be only a matter of time before the country went broke again—like in the late 1990s—and the monetary straightjacket would be abandoned in disgrace.

　　Rueff saw with his own eyes, drawing on his acute understanding of fiscal and monetary phenomena, how the Nazis were able to collect, directly and indirectly through their puppet regimes like Vichy, real resources from France and other occupied countries to feed their war machine. This was from a population—we may assume—that was not keen on paying taxes to them.

　　Nazi Germany, because they could not count on the collaboration of (most) of the population of countries they invaded, was forced to issue “false” claims on the existing goods to extract them from the ones who produced them.

　　We are not implying that there is a comparable level of illegitimacy of a merely “Peronista” regime with Nazi Germany. The point is simply that Rueff, in Vichy, France, was able to see the mechanics of extracting real wealth from the population by monetary means in its crudest form. The theory he developed in this context helps explain why, with the limited options at his disposal, Milei has started to rebuild a liberal economy in Argentina on a foundation of fiscal austerity.

　　Suppose he succeeds in bringing inflation to zero by keeping a balanced budget with no monetary financing. In that case, a neutral exchange rate may be achieved without triggering hyperinflation and allowing competition in money.

　　Like many, however, we doubt the wisdom of the current “deflationary” policy of financial repression via a fixed exchange rate and capital controls. In that,Milei and Caputo diverge from the “monetary conservative” Jacques Rueff’s most famous lesson. A realistic exchange rate (the price of national money compared to the price of all other monies) and the interest rate (the price paid to have money now given our time preference) are the two most important prices in the economy.

　　These, if manipulated by the government, produce the most distortions. Vide the different results obtained by France in 1926, which returned to the gold standard after an 80 percent devaluation, and the ones obtained by the UK, which returned to the gold standard in 1925 at the same parity as before World War I despite the 100 percent inflation during the war.

　　Like the French, Milei may be forced to a second round of devaluation before reaching a price of indifference for the exchange rate and allowing “endogenous” dollarization by ending capital controls. There may be a narrow path in front of him to justify all the economic pain imposed on Argentineans so far without wasting the positive results already achieved. Is that what Milei wanted to do when he came to power? We doubt it. Nevertheless, as it has been understood since Roman times, “Sator Arepo Tenet Opera Rotas” (the farmer Arepo needs to plow with the plow he has). In a closed economy like Argentina’s, the constraint is one of real resources, and this problem manifests itself in fiscal imbalances that are the real cause of the monetary irrationality. If the present difficulties open the way to a wider recognition that fiscal imbalances are the root cause of inflation, they may be a providential tool for helping him succeed.