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Argentine alert as inflation specter stalks half the world
In the 1990s, Argentina was Latin America's star. How did it become a basket case? For now, politicians and banks are the scapegoats. Several politicians have been beaten up and abused on the street.
For now, politicians and banks are the scapegoats. Several politicians have been beaten up and abused on the street. By seizing its citizens' savings, the government has broken a basic contract, and violated the rule of law. Trust between government and citizens—the essential glue of a prosperous democracy—has been destroyed. The past few weeks have seen Argentina default on its $155 billion public debt, the largest such default by any country in history.
Even before the latest disaster, Argentina's story is that of a decline unparalleled in modern times. Blessed with some of the world's most fertile land on the endless pampas, Argentina in the 19th century attracted a flood of British capital and European immigrants. By 1913, having grown at an annual average rate of 5% for the previous three decades, it was one of the world's ten richest countries, ahead of France and Germany.
It has been downhill ever since. Exporting beef and grain to Britain ceased to be a passport to prosperity. But Argentina's leaders, starting with Juan Domingo Peron, a populist army colonel who ruled from 1946 to 1955, aggravated their country's problems by retreating into protectionism and financing generous benefits to workers by printing money...more
Catching Argentinean Disease by John Mauldin
At the beginning of the 20th century, Argentina was the seventh richest nation on earth. It's very name means "silver." "As rich as an Argentine" was a byword. Even after falling from the heights through a series of bad decisions, the country was still so wealthy that, in 1946 when new president Juan Peron first visited the central bank, he could remark that "There was so much gold you could barely walk through the corridors."
Argentina had actually defaulted on its debt in the late 19th century, not once but twice! But still they managed to avoid destroying the currency and devastating the country. But in 1989, after years of massive budget deficits that were financed with borrowing from abroad and Argentinean citizens, the country was left with so much debt and no one was willing to lend it any more money, that the leaders felt compelled to resort to the printing press.
My Uruguayan friend and Latin American partner, Enrique Fynn, tells me of his experience of going to Buenos Aires and buying a pack of cigarettes one evening. He went into the store the next morning for another pack, and the price had doubled. He came back that evening and the price had doubled again (thankfully for his health, he has quit!). There were no prices on any items in the grocery stores. There was a man with a microphone who would announce the prices of various items, often increasing the price every few hours by 30% or more.
Workers would get their pay in cash and rush to the store to buy anything, as by the end of the week their pay would be worthless. Of course, shelves were empty. The US dollar was king, and could purchase things at amazing prices. I heard stories that were truly compelling. (It made me wish I had gone shopping in Buenos Aires at the time!)
Interestingly, the dollar is still the real medium of exchange. I was told by several people that if you want to buy a house for half a million dollars, you bring the physical cash to the closing. One person counts the money and the other checks the paperwork and title. Argentina has the second largest hoard of physical dollars in the world, only exceeded by Russia. Is it any wonder they are concerned with the value of the dollar?
Let's look at some quotes from Ferguson (emphasis mine):
"The economic history of Argentina in the twentieth century is an object lesson that all the resources in the world can be set at nought by financial mismanagement... To understand Argentina's economic decline, it is once again necessary to see that inflation was a political as much as a monetary phenomenon..
"To put it simply, there was no significant group with an interest in price stability...
"Inflation is a monetary phenomenon, as Milton Friedman said. But hyperinflation is always and everywhere a political phenomenon, in the sense that it cannot occur without a fundamental malfunction of a country's political economy."
Look at the chart below. Using realistic assumptions, It suggests that the annual US government fiscal deficit will approach $2 trillion in 2019. How can we come up with what looks to be about $15 trillion over the next ten years? The Argentinean answer was to print the money.
In the US, the short answer is that unless the US consumers become a massive saving machine, to the tune of 8% or more of GDP and rising each year, and willingly put their savings into US government debt, it's not going to happen. So sometime in the coming years, interest rates are likely to start to rise in order to compensate bond investors for what they perceive as risk. That will bring us to some very difficult and painful choices.
Ferguson pointed out in the quotes above that hyperinflation is always and everywhere a political decision. Governments have to choose to print money. In theory and in practice, what would happen if the Fed decided to accommodate a politicized US government that wanted to spend money on favorite projects and support groups, maybe even deserving programs like health care or defense or pensions or Social Security? Money they could not borrow?
Then Peter Schiff and like-minded thinkers would be right. Once you start down that path, it is hard to stop short of the brink. Brazil got to 100% inflation per month and has really lowered that level over time, but it is not easy.
In such a scenario, you want to own hard assets. Gold. Foreign currencies. Stocks. Almost anything other than the currency that is being printed.
I was asked at almost every speech about that scenario. In Latin America, hyperinflation is not a theoretical issue; it has been reality. More than one person commented on that no one in US economics schools studies hyperinflation. It is required material in Latin America. For many Latin Americans, the dollar has been their safe haven. And now they are worried, with good reason.
For the record, I do not think the US will experience hyperinflation as long as the Fed maintains its independence. Read the speeches from various Fed governors and regional presidents. These are strong personalities, and they understand that going down that path ends in massive tears. Bernanke warned just a few weeks ago that the government needs to get serious about the fiscal deficit. Watch the rhetoric from the Fed heat up after his reconfirmation and the confirmation of two new governors in the first quarter.
The Fed has committed to buy a fixed amount of government debt in its quantitative easing program. That commitment will be finished by the end of the first quarter (if I remember correctly). Then comes the tricky part.
"Argentina is the closest example one can find to what is about to happen in the US."
Ambrose Evans-Pritchard- Last Updated: 6:39am BST 02/06/2008
Argentina is defaulting on its sovereign debt yet again, this time by stealth. Wealthier Portensos with a nose for trouble are pulling their savings out of Buenos Aires banks. Most are buying dollars, or slipping across the Rio de la Plata to deposit their stash in Uruguay.
European and US pension funds that snapped up Argentina's peso bonds at the height of the credit bubble are discovering that it pays to probe the politics of Latin America - and indeed, Eastern Europe, and emerging Asia - before taking the plunge.
It seems like only yesterday that Argentina halted payments on $95bn of external debt. The "Great Haircut" of 2001 was the biggest default in history. Investors are so forgiving.
Argentina's trick this time, under the presidential double act of Nestor and Cristina Kirchner, has been to purge the National Statistics Office and appoint a friend to manage inflation data (where else are we seeing this?). The official Consumer Price Index (CPI) is 8.9pc. This is the benchmark used to set payments on inflation-linked bonds, now 40pc of the country's debt. The true inflation rate is more than 25pc, according to union staff of the statistics office. They allege manipulation. St Luis province is issuing its own data, three times higher.
"Argentina is engineering a partial default on its domestic debt," said Professor Carmen Reinhart, from Maryland University. Some $300bn of inflation-linked bonds from Turkey, Hungary, Poland, Mexico, Brazil, South Africa, and other emerging markets (EM) have been sold, mostly to pension funds. Bankers in London and New York have hawked the debt with the same insouciance that they hawked US sub-prime mortgages. These "Linkers" were also deemed to be as safe as houses. Well, not quite.
Vladimir Werning, from JP Morgan Chase, said the yield spread on inflation-linked peso debt has ballooned to 1230 basis points. They are priced for the dustbin.
On paper, Argentina looks safe. The world's biggest exporter of soybeans - and number two in corn - is riding the food boom, even if at war with its own farmers. The trade surplus is $12bn. Foreign reserves are more than $50bn. Yet the default premium is soaring anyway. Argentina is a warning of what can go wrong once inflation gets out of hand, as it has in roughly half the world.
Among the CPI rates - if you believe them - are: Ukraine (30pc), Venezuela (29pc), Vietnam (25pc), Kazakhstan (19pc), Latvia (18pc), Qatar (17pc), Pakistan (17pc), Egypt (16pc), Bulgaria (15pc), Russia (14pc), the Emirates (11pc), Estonia (11pc), Turkey (9.7), Indonesia (9pc), Saudi Arabia (9.6pc), Romania (8.6pc), China (8.5pc) and India (7.6pc).
The International Monetary Fund says 70pc of the EM inflation shock came from soaring food costs last year (typically 40pc of the basket, versus 12pc for richer states). But the home-grown part is fast gaining a life of its own. "Easy money is the culprit," says Joachim Fels, chief economist at Morgan Stanley. "Weighted global interest rates are 4.3pc, while global inflation is above 5pc. The real policy rate in the world is negative. Central banks are both fuelling and accommodating the rise in food and energy prices," he said.
Fixed exchange rates are playing havoc. Most Gulf states are pegged to the dollar, while China runs a crawling peg. These countries are importing the emergency stimulus of the US Federal Reserve when they least need it.
Across the EM universe, states are now hitting the inflationary buffers. Either they hit the brakes, or risk repeating the errors of the 1970s - if they have not already done so. Some are rising to the challenge. South Africa is turning the monetary screw. Others dawdle. Russia seems paralyzed, while Ukraine's M2 money supply is growing at 52pc. A clutch of states is relying on price controls, export tariffs on food, or worse. Fitch Ratings has put Vietnam on negative watch, citing the failure to come up with a realistic policy. Inflation is 25pc, now twice the level of interest rates (12pc). Real rates are "deeply negative".
Fitch's David Riley said credit growth had blasted through the speed limit across the whole arc of Eastern Europe from the Baltic states to the Black Sea, and beyond. The top ten states liable to have an accident are: Jamaica (1), Ukraine (2), Kazakhstan (3), Bulgaria (4), Suriname (5), Latvia (6), Lithuania (7), Ghana (8), Vietnam (9) and Sri Lanka (10).
"Failure to contain inflation risks undermining macroeconomic stability. In the worst-case scenario, investors will lose confidence in local currency assets," he said.
This decade has been a great coming of age for the catch-up countries. Bond yields have dropped to western levels. Exotic bourses have been the darling of the City. The MSCI index of EM stocks has risen fourfold since 2003. It suffered a mini-crash before the Fed rescue in March, but has bounced back.
China, Russia, and others have amassed a war chest of reserves to see them through bad times. Most no longer borrow much in foreign currencies - although the property booms across Eastern Europe are funded in Swiss francs and euros. Some have independent central banks. Credibility is higher. By and large, a repeat of the 1997-1998 Asian crisis is out of the question. Nor will there be a repeat of the Latin debt defaults following the 1970s resources boom.
But Professor Reinhart warns that investors may have jumped from the frying pan into the fire. The risks have been displaced from an external debt crisis to an internal crisis of the kind seen time and again over the history of free capital flows. She has examined debt data for 64 countries going back a century. Defaults - 89 of them - occur with monotonous regularity in the same cluster of states, usually triggered by a global slowdown and a commodity slide. Those with big domestic debts often resorted to "partial defaults" through the easy path of inflation. "Technology has changed, the height of humans has changed, and fashions have changed. Yet the ability of governments and investors to delude themselves seems to have remained a constant," she said.
"Governments that have repeatedly inflated away or defaulted on their debts will, in all likelihood, not hesitate to default again," she said.
Never buy a bond until you know who runs the statistics office