My recent discussion with Philipp Bagus has reached a saturation point as far as the core issues are concerned. Our readers are now in a position to make up their own minds. Those with eyes to see, they have seen.
In what follows, I will offer a few concluding thoughts.
What would have happened if the Milei government had closed down Argentina’s central bank, as promised, right after taking power in December 2023? This was the starting point of our discussion. It was a rather academic question.
Indeed, as is well known, Javier Milei did not shut down Argentina’s central bank.
And of course, there are perfectly sensible reasons for this decision. We may add that such reasons are always readily available. The government did not wish to precipitate the country into a terrible economic crisis right at the onset of the new presidency. The president did not wish to alienate his voters. He did not wish to antagonise the (highly leveraged) economic and political establishment of Argentina, the so-called elites around Caputo, Daza, Sturzenegger et alii, who have been, and are still, so well represented in his cabinet.
Considerations of this sort are the hallmark of the middle-of-the-road social democrat or Christian-democrat “conservative” leader, the proverbial party politician, honourable member of the political caste. The little problem is that Javier Milei presented himself as being passionately opposed to all of this. He was Argentina’s Mr Libertarian. He promised to cut government as far as possible, to shut down one state organisation after the other. Afuera! Out!
So why stop when it comes to the central bank? Let me quote, again, the socialist Yanis Varoufakis: “If you (unlike me) truly believe in the markets’ superior wisdom, and want to rid Argentina of political constraints placed on the market mechanism, which market do you liberate first? The money market, surely.”
And indeed, during his presidential campaign, shutting down the central bank has been one of the most popular items in Javier Milei’s programme. Many people voted for him precisely because they wanted to see this happen. It goes without saying that this electorate would have been utterly disappointed if their champion had told them that he did not wish to get cross with his new friends from the establishment. But which argument would get him out of the political impasse?
Most politicians would have argued that shutting down the central bank would have created a terrible deflation, along with a collapse of the stock market, high unemployment, and great economic hardship for almost everyone. The problem with this argument is that most Austrian economists see nothing wrong in price-deflation. Even when it comes to deflationary meltdowns, they typically highlight the long-run benefits of such a deflationary purge. I’m not just talking about myself and Joe Salerno, and Mark Thornton. Jesus Huerta de Soto and Philipp Bagus, too, are on the record as vocal critics of deflationphobia. Price-deflation is not a problem for the economy as a whole. It is a short-run problem for highly leveraged agents (especially the so-called elites), but this is a one-time problem that is bound to vanish very fast, leaving behind a largely debt-free economy, more robust than ever.
In short, there was no way Milei could justify himself with this argument and preserve his credibility.
And he did not come up with this justification. Rather, he argued that shutting down the central bank would be tantamount to hyperinflation.
Politically, this was very smart. Austrians oppose central banking, not least of all because it entails massive money-stock inflation and price-inflation. Hence, if shutting down the central bank entailed the very evil for which central banks were despised, well, then this policy seemed to be counter-productive, after all.
Now I won’t discuss Milei’s wrong explanation of why eliminating the central bank would lead to hyperinflation. Kristoffer Hansen has already done this with great clarity. When I heard Milei making this claim, I thought that the man was a very bad economist. Certainly, he could not in any way be considered to be a representative of the Austrian School of economics. This is also why I argued, along with my colleagues Rolf W. Puster and Hans-Hermann Hoppe, that Milei cannot be taken seriously when he pronounces himself on Austrian economics. He quite obviously does not know what he is talking about.
But then comes my old friend Philipp Bagus and also asserts, though not with quite the same arguments, that shutting down the central bank would have entailed a hyperinflation in Argentina. This gave me a pause. Clearly, I may have been too harsh on Milei. Maybe he had received the idea of this sort in discussions with Philipp Bagus or some other Austrian economist (I should be grateful if Prof. Bagus could shed some light on this question). And I also became very curious about how an intelligent and well-trained man such as Bagus could come to endorse such nonsense. And this is how our little discussion started.
From the very outset, Prof. Bagus has been defending a hopeless case. He never could get around two basic facts. (1) Closing the central bank would have led to a meltdown of the money stock, and this alone would have overridden any countervailing influence coming from other factors, such as the demand for money. And (2) the demand for money is itself largely dependent on the perceived evolution of the money stock.
If Javier Milei had shut down the Argentinian central bank on day one of his mandate, then the base money stock (a liability of the central bank) could not have increased anymore. Existing peso notes would either have remained in circulation or been liquidated in exchange for assets held by the central bank. Existing cash accounts held at the central bank would either have been exchanged for peso notes, or liquidated in exchange for assets held by the central bank. And all other debt (including the overnight deposit facilities mentioned by Prof. Bagus) would have been liquidated in exchange for assets held by the central bank.
In short, the base money stock would either have remained constant or, more likely, have shrunken quite considerably. Moreover, and this is the crucial point, the overall money stock (base money and deposit accounts held at the commercial banks) would have diminished precipitously. Without central bank support, many (if not most) of the commercial banks would have gone bankrupt, and all others would have been forced to unwind their loan business and to increase their cash reserves. (One may argue that this movement was well underway and showed up in the swelling amounts of overnight deposit facilities during the final phase of the election campaign, when Javier Milei was still promising that he would close the central bank.)
But the commercial banks would not be the only market participants who would have increased their demand for pesos. All others would very quickly have done the same. The reason is that the peso base money stock would have been frozen, and possibly would even have diminished. And the demand for money, while having multiple causes, is very largely determined by the expected variation of the money stock. In late 2023, the demand for pesos was going downhill. But this was not least of all because the money stock (and therefore also the price level) had been relentlessly increased by the central bank. Shutting down the central bank would have very quickly reversed this tendency.
The entire strategy of Philipp Bagus’ argument, as far as the demand for money is concerned, has boiled down to eclipsing as far as possible the crucial role of the perceived evolution of the money stock. He has told us a mesmerising story about the “loss of confidence” that would have been worsened if the central bank had been shut down, and which would have entailed a hyperinflation, come what may, with the money stock.
I found this fascinating. It reminded me of Carl Schmitt’s book on Political Romanticism, a form of poetic license when discussing political questions. In Professor Bagus’ statements I found a form of “economic romanticism” – a story that was not logically impossible and therefore not absurd, as a square circle, but which clearly exaggerated in a surprising way the influence of some element of reality (the demand for money), bringing it out of proportion and out of tune with its true role in the real world.
Hopefully, our readers will have found this discussion enlightening. I look forward to reading Philipp Bagus’ concluding statements and thank him for responding to my objections.
