Argentina's financial crises

Bill Bonner - Fri 02 Jun, 2006

...In less than 10 years, [Argentina's] surpluses were squandered and the nation was already suffering its first financial crisis of the post-war period. There would be many more...

"All progress is based upon a universal innate desire on the part of every organism to live beyond its income."

Samuel Butler, Notebooks, 1912

In the late ‘80s and early ‘90s the airlines were doing a brisk business shuttling economic advisors across the equator. We know; we were among them.

We once accompanied a group of investors and economists on a visit to the Casa Rosada in Argentina during this frenzied period of economic counselling, where we found President Carlos Menem looking friendly but short.
Argentina’s many financial crises seemed to have taken the inches off of him. He had done something even more remarkable than Paul Volcker. He had reduced the inflation rate from 200% per month to just 4% per year, by pegging the peso to the dollar at a one-to-one rate.
But he seemed only half as tall as Volcker.

But our group was stone sober and barely interested in height; what we wanted to know was whether the gaucho would be able to maintain the peso equal to the dollar.

"Yes," was the answer we got from the president of the pampas.

"No," was the fact of the matter. A few years later, the peso peg broke off like an airplane wing and the Argentine currency suddenly crashed 60%.

That was not the end of our little chat. We got some advice and we gave some. The advice we got was that Argentina was safe for foreign investment; indeed, it was most welcome. The advice we gave was: "dollarize."
Our advice proved better than his.

Then as now the United States of America was the world’s dominant financial power. And the coin of the realm was, then as now, not coin at all, but paper. Converting to dollars would take Argentine monetary policy out of its own hands. Judging from the evidence, past and future, it surely would have been a good idea. Rather than let the Bank of Argentina manage the nation’s money, it would be in the hands of Alan Greenspan.

Little did we know at the time, but Alan Greenspan had tango in his blood too. Still, it was good advice.
Argentina should have followed it. Instead, its own people juiced up the money supply at an average rate of 60% per year between 1991 and 1994. In 1996 and 1997, it went up at 15% and 20% respectively. It didn’t take long before prices were rising again and investors were beginning to call their banks in Miami. Even with very strong economic growth (Argentina grew at an 8% rate in the mid-‘90s, second only to China) the government still could not balance the budget. Public sector debt soared.

By 1998, The Argentine was in a slump; it needed to borrow more and more money to keep up with spending and make up for lost tax revenue. By late 2000, one out of every five bonds issued by an emerging market country was Argentine. Investors began to wonder how the country could ever make good on so much debt. Speculators started dumping Argentine bonds and withdrawing capital from the country. Scarcely a year later, the whole jig was up. The currency peg was soon broken. The peso collapsed, and along with it the Argentine economy.
Unemployment soared. Banks were closed. Deposits were confiscated. And Argentine's middle class was practically wiped out.

But Argentine failures are not why we turn today to the underside of the world below the equator. We cross the wide River Plata not to offer advice but to seek it for we sense a financial crisis coming here in the north.
Who knows more about how to survive it than the gauchos down south?

So let us back up to a more benign period in Argentine history when the country was so blessed by nature that people lived as happily as Gott im Frankreich, until the 1930s. Before WWII, Argentina exported beef and farm products the way France now exports champagne and petit fours. During the war, the country was able to sell its produce to the combatants at a sizeable profit. By the war’s end, Argentina was a substantial net creditor to the rest of the world with an annual current account surplus of more than $6 billion (1950 dollars, which is to say, when the dollar was worth about 10 times as much as it is today.) Left alone, the country probably would have gradually diversified its economy, improved its brands, sharpened its marketing and prospered at about the same rate as other European nations. As we will see, the spirit was willing, but the cash was weak. In less than 10 years, the surpluses were squandered and the nation was already suffering its first financial crisis of the post-war period. There would be many more.

Argentines have their own opinions about what went wrong. When the most recent crisis hit, in 2001, they voiced them:

"People are dying because there is no food," wrote one.
"People are dying and are going to die because of lack of treatment for common illnesses: asthma, heart attacks, malnutrition, etc. We owe that to corruption."

"You could buy anything from anywhere [before the crisis, now] not even Tylenol can be found on pharmacy shelves..." adds another eyewitness. "The price of typical cereal has tripled, and even people with overseas accounts can’t access them...Crime has increased exponentially as have the number of poor people begging in the streets."

"The middle class, something we used to feel proud of, is now disappearing," wrote another.

As you might expect, most people blamed the convenient bogeymen; greed, corruption, the US and the IMF. But one brought the hammer down squarely on a home-grown
culprit:

"All our problems effectively started as far back as 1930," wrote Juan Casador, "with the ‘radical’
revolution. World War II was a respite and at the end we were very rich compared to Europe. Then came Peron who squandered it all. After that came the military who borrowed heavily. This is the basis of our current debt.
All governments, since the military was thrown out by Maggie Thatcher, have been crooks. And stealing is a way of life. Any Argentine who does not steal is mad at those who do, until he gets a chance at it himself. We are a nation of liars, cheats, bullies and thieves. We deserve what we get."

On whether or not Argentines deserve what they get we have no opinion. But, last week, we proposed a theory for what went wrong in Argentina not too different from Juan’s – Peronism. It was another Juan, Juan Peron, who brought National Socialism to Argentina in the war years. And at the close of WWII, when the other National Socialists were either hanging from hooks in Rome, or being incinerated in Berlin, Peron refused to die. Italy and Germany were reconstructed after the war, but in Argentina, Peronism lived on.

What is Peronism?

We’ll let the man who invented it answer. "Peronism,"
said Peron himself, "is a new political doctrine." We followed him up to that point. Then we were lost:

"[It] is a theory which establishes a little equality among men and assures them of a future so that in this land there may be no one who lacks what he needs of a living...its aim is that every Argentine should pull his weight for the Argentines...Peronism is not learned, nor just talked about: one feels it or else disagrees.
Peronism is a question of the heart rather than of the head. I feel an intimate satisfaction when I see a workman who is well dressed or taking his family to the theatre. I feel just as satisfied as I would feel if I were that workman myself. That is Peronism."

Peronism was neither capitalistic nor communistic.
Instead, it was advertised as a ‘third way.’ What it really did was to take the worst elements from each. It was central planning, without plans. It was price fixing, without fixed prices. It was higher wages, with lower real earnings. It was crackpot economics, with the cracks and minus the pots. It was huge new porkbarrel projects, without the pork; and doggles, without boons.

Peron’s government followed in Mussolini footsteps, encouraging higher levels of consumption, higher spending for government, more regulation, huge new doses of debt, nationalism, price controls, inflation and special treatment for favoured industries, particularly defence. This was a revolutionary new program for South America at the time but a dead ringer for the Republic Party platform of 2004. Peron called it Justicialismo.
It could as well be "compassionate conservativism." It was even Peron who invented the notion of a ‘Homeland,’
ranking it number one on his ‘scale of values.’

Once the Peronists were in control, the surpluses disappeared. Overspending and over-meddling produced their inevitable result. The economy began to wobble.
What could Peron do? He was no economist, not even a quack one. But a skilful politician can just as well wreck an economy as build one up. Lies are what count; if he can tell whoppers well enough, he’ll be able to pin the blame on someone else. And gather even more power to himself to fix it! Peron looked around. There they were; the rich, the traitors! The conservative old families, the stick in the muds! And the Catholic Church!

Peron’s world improvement ambitions went beyond finance and economics. He planned to legalize prostitution and legalize divorce. When the church opposed him, he sent out his trade union goons to sack every major church in Buenos Aires. And when the old money squawked, he burned down the Jockey Club.

By now the idealist was really getting wound up:

"With our tolerance stretched, we have earned the right to punish them violently. From now on the order for every Peronista, alone or in a group, is to respond to an act of violence with another act of violence. And whenever one of us falls, five of them will fall."

Soon he had gone too far. He was inciting his followers to mob violence, the very thing the military most feared. The army rose up against him. On the 16th of September, 1955, the Cordoba garrison broke out in open revolt. Navy warships blockaded Buenos Aires and threatened to blow up the oil refineries on the Rio Plata. A cruiser began shelling the docks on the 18th.
General Pedro Aramburu declared himself against the regime in the North East. General Lonardi swept into Buenos Aries itself on the 23rd, greeted by cheering crowds.

Peron was finally gone. But when he left office he left, in the words of Argentine economist Raul Prebisch, a "crisis of unparalleled gravity." Instead of investing in industries that might have created jobs and profits, people had shifted to speculating and had taken their money overseas to protect against inflation and devaluations. On their own, the smart gauchos had learned how to dollarize themselves.

The economy slumped. Prices rose. The Argentine experienced 'stagflation' years before it hit the US.
The money supply exploded. Corruption became common. The middle class, too, tried to duck and dodge the Peronist economy. A large part of the economy went underground.
Half of all eligible taxpayers didn’t bother to file a return.

The generals quickly tried to undo the damage. But now the whole rotten system was beginning to stink. The workers demanded higher wages. Prices rose out of control. Debts increases. Taxes went unpaid. Peronism wouldn’t die. New crises came; devaluations, inflation, strikes, coups d’etat, defaults, revolutions and continued for the next 35 years, right up until the early ‘90s. Each of these crises had Peron’s fingerprints all over it, for they were the products of the old ‘justicialismo’ - too much spending, too much debt, too much currency, and too much meddling. Debts mounted up even higher. Banks tottered. Inflation rose to 600% and then to 2,000%, then to 4,000%. Budget deficits rose to 13% of GDP. External debts reached 44% of GDP.

Then, Carlos Menem, a member of the Peronist party, linked the peso to the dollar, on a 1-to-1 basis and began, again, to remove the Peron-era controls. Finally, with this new, more solid money, the economy breathed, it opened up, it prospered. Argentina was escaping the dead hands of Peron at last. Just to make sure, someone broke into Juan Peron’s crypt in La Chacarita Cemetery and cut his hands off!

Even that was not the end of it. While Menem reformed, the old habits continued. Debt. Spending. Inflation.
Finally, the government caved in and the peso collapsed.
Once again, in 2001-2002, Argentina was in crisis.

But the Argentines are resilient. The economy has been recovering for the last three years. In 2003, the economy grew at a rate even India would be proud of - 8.4%. The cafes are filling up. Prices are rising. The country would probably prosper, if the Peronistas would just leave it alone.


Regards,

Bill Bonner
The Daily Reckoning