Argentine economist Horacio Pozzo says that government manipulation of inflation figures in Argentina could take the country beyond the point of no return. For investors with a stake in the Argentine economy, Horacio is a must read…

Most parents have heard those barely credible ‘I won’t do it anymore’ promises from a misbehaving child.

In Argentina, the public dared to believe the misbehaving government. ‘When the new CPI index is introduced, it will start to reflect what is really going on with prices in the economy’, they hoped.

But, while the government reports monthly inflation at 0.6%, private estimates are more than double the official rate. What’s going on? Are private analysts grossly mistaken?

That’s what Commerce Secretary Guillermo Moreno thinks. “The true indexes are the official ones. Anything else is just speculation.”

Let’s take a look at a topical example. As daily headlines inform us all, food prices around the world are soaring. But in Argentina, which is suffering from shortages of some goods due to a major agricultural strike, they are rising at just 0.7% a month. Interesting…

The ‘food & drink’ category of inflation is critical for poverty indicators. So there is a clear motivation for the state to try and keep official figures from reflecting the recent surge in prices. And so, in Argentina, while poverty indexes are in decline, the view from the streets paints a very different picture. And it’s not some visual illusion, as the government claims. You just have to step outside to see what’s really going on throughout the country.

Poverty isn’t the only indicator ‘benefiting’ from under-reported inflation data. Real GDP growth also gets a boost. Why? Because price indexes are used to ‘deflate’ economic activity. Put simply, any part of nominal growth that is not put down to price increases must be due to higher output.

Of course, the list of negatives associated with the deliberate manipulation of inflation data is much longer than this. Some of the notable others are: fewer new investment projects in the economy, capital flight away from national public debt, limited (or no) access to international financial markets, and distortions in relative prices. Worst of all, it makes it impossible to tackle the actual inflation problem.

This situation hits every investor with a stake in the Argentine economy, whether it is in the real economy or financial markets.

In the real economy, the unpredictable price dynamics (that is, not the official ones), make it impossible to forecast future returns from investment. Even short-term projects become difficult to evaluate in the current environment. For example, two months ago you might have invested in Argentina’s export sector, following consensus forecasts for further peso weakening. You’d be pretty annoyed that the Central Bank unexpectedly changed position, and has prompted the peso to appreciate from AR$3.21 to AR$3.04 during that period.

In capital markets, things aren’t much better. On top of an undeveloped and inefficient local market, Argentine paper is becoming more and more volatile as instability in the economy increases.

Perhaps the biggest deception in the price indexes is creating the illusion that things are going in the right direction. They are not. The government wants you to believe that inflation is stable, when it is rising in all other corners of the world. That poverty levels are falling. That growth rates comparable to China are positive (even as this seems impossible given current conditions). And all the while, actual inflation will continue to harm the economy, until we reach a point of no return. By then, it will be too late.

Until tomorrow,
Horacio Pozzo