22 August 2001 - Cry for Argentina

Argentina is in trouble. In fact, I doubt if I could dream up a more-dire situation for this South American behemoth.

The currency is on the verge of devaluing. The government is about to default on its debt. The stock market has plummeted 25 percent since the beginning of the year. And just about everybody in the world who has invested here mutual-fund companies, insurance outfits, international investors is yanking their money and heading for the hills.

“But Jim,” you might ask, “isn’t this the kind of buying opportunity about which you dream, the kind of bottom with no direction but up?”

Yes, I’ve preached a ‘buy-at-the-bottom’ investment style where you search through the rubble for bargains that often turn into stellar investments, if not gold mines, when the smoke clears.

But I’ve also suggested a ‘bottom’ shopping spree should come when there’s a mood of economic panic. That’s what’s missing in Argentina and the cavalier attitude may be the worst strike against the country, even with all its other problems.

Frankly, I’ve found no palpable concern for what’s happening in the economy. The press may run economic numbers and stats daily, like the one showing how much bank deposits are declining down $6 billion in July alone but everyone seems convinced the current government, led by President Fernando de la Rua, can solve the problems. Everyone I’ve talked to says, “Don’t worry. We’ve had problems before and we’ve always worked them out.”

I wouldn’t call that even a sense of urgency, much less panic.

How did Argentina get this way? The current problem traces back to an economic fix made decade ago. In 1991, when hyperinflation reached 3,000 percent, Domingo Cavallo, the economic minister at the time, solved the problem through dollarization: pegging the Argentine peso to the U.S. dollar. In theory, this strategy makes the country more fiscally responsible, stopping the government from simply printing more to deal with any economic downturn.

For a long time, Argentina sizzled like one of its outstanding steaks. Its economy grew more that 40 percent during the 1990s as foreign investors raced to put their money in the banks. When I was in Argentina in 1991, Sr. Johny Pena, the President of the Stock Exchange, was only too delighted to receive me but was skeptical of my optimism.

I was so confident in the country’s future I opened two brokerage accounts: one with the Galicia Valores, the brokerage arm of Banco Galicia, one of Argentina’s largest banks, and one at the Buenos Aires branch of JP Morgan.

I figured Argentina was fast on its way to regaining its status as one of the richest countries in the world. During the early 1900s, Europeans labeled a wealthy person as someone who was “as rich as an Argentine,” just as Americans called someone “as rich as a Texan” during the oil-boom days.

In the mid 1990s, I sold most of my investments because I already could see storm clouds brewing, especially with the government’s growing appetite for borrowing. By contrast from 10 years ago, on this trip, Sr. Pena “did not have time” to receive me, perhaps because he knew how my views had changed.

Although I sold most of my investments, I did keep some money in my accounts. Investors can keep their money in dollars or pesos. I went with pesos because the interest rates were higher on pesos. As I saw government borrowing spiraling upwards, I switched to dollars even though the rates were lower. Now I am just joining the exodus.

Today, Argentina is in a class by itself when it comes to debt. The country owes about $130 billion, or roughly half its gross domestic product, and Argentine bonds account for about a quarter of debt issued by emerging markets. Although the government has successfully rolled over debt payments each year, or pressed the International Monetary Fund for further aid packages, it has only delayed the inevitable.

Pegging the peso to the dollar did little to foster a competitive economy. Argentina’s neighbors like Chile and Brazil depreciated their currencies in order to sell more goods on world markets. Also, the dollar kept rising, making Argentina even less competitive.

This is particularly problematic given Argentina’s is an incredibly protectionist economy that collects huge tariffs on imports. An auto dealer told me parts often sit in customs for up to 10 days before being allowed in. It’s virtually impossible to bring foreign pharmaceuticals in.

Compare that to Chile where the current government pushes free trade at almost every turn, imposing virtually no tariffs on anything except luxury goods. The joke among foreign business people I talked to in Buenos Aires is that Argentines like to make money but no one wants to do business.

I encountered that approach everywhere. When I looked at hotels, I was shocked to discover prices equal to those in four-star hotels in Hong Kong or New York City. In most places where the economy is suffering, hotels lower the rates because it’s better to have some guests paying something than an empty hotel and empty coffers. In Argentina, everyone is wearing blinders to the economic problems.

Argentina’s postal rates aren’t even competitive. In Chile, it cost me $.40 for a stamp to send a postcard to the U.S. That same stamp was $1.25 in Argentina. Americans can mail a postcard to Argentina, Brazil or Chile for $.70.

Ironically, the Argentine government brought back Cavallo, the same man who orchestrated the dollarization, to remedy the problem. During his previous tenure, he paid his advisors at CSFB millions and millions of Argentina’s dollars for advice that has turned out to be disastrously dead wrong. I doubt those advisors will return the money now to help the country even though they have been so wrong.

Cavallo has won the government some brief breathing room by swapping short-term bonds for long-term ones but that’s just a Band-Aid on a gaping wound, if you ask me.

But the government has severe structural problems from the bottom up, starting with systems bloated with waste. We can attest to it in a small way.

As we’ve driven across the country, we’ve been stopped repeatedly by police checkpoints, often every 80 meters. We were reminded of Russia or Georgia or several African nations.

And every time, we had to show our papers. I cannot imagine how they think we got to the middle of Argentina with this unique car without proper papers. Perhaps the officers think we were beamed down from a space ship. Or perhaps they doubt the efficiency of the previous check point just down the road.

Whether the bureaucracy is a way to buy votes by providing jobs, a holdover from military governments, or a way to remind the citizens the government can control them, it’s a total waste of time, money, energy and efficiency!

Argentina, as I see it, has two options, neither of which paints a particularly rosy picture. The country can default on its loans, but it would be a long time before anyone is willing to give it credit again. Rest assured, default will come, possibly as early as this fall but certainly by next year.

Argentine officials also could devalue the currency, cutting the peg from its current one-to-one ratio with the dollar, to something like two pesos for every dollar, or maybe even 50 pesos for every dollar. The currency would at least fall to realistic levels rather than being artificially inflated.

That action has a big downside, however. Banks here lend money in dollars, not pesos. The history of the Argentine peso is so horrible that banks make you pay back mortgages in U.S. dollars. In fact, 70 percent of all private debt is denominated in dollars.

If the peso is devalued, chaos would ensue. The cost to finance mortgages would skyrocket. Unfortunately, devaluation also likely will occur. But the government will put off such a move as long as possible, because of its terrible impact on many Argentines.

President de la Rua offers hope in a third option, an austerity plan his seventh in the past two years that includes cutting government salaries and pensions and promises the government will spend only what it makes while managing to pay off its debt.

With investors stampeding for the doors, I’d really like to know how he intends to do that.

An austerity will come at a time when Argentina needs to be addressing severe infrastructure problems that have crippling implications if the country hopes to prosper and be competitive in the global economy.

The national highways are crumbling with potholes. Contrast that to Chile where a privatized highway system boasts four-lane toll roads on which you speed up and down the country.

Likewise, Argentina’s telecommunications system is a mess. I bought a cellular phone with a local provider in order to make calls to people in the U.S. No one in the U.S. could reach me. I was supposed to use the phone to receive e-mail and connect to the Internet. No chance.

I would have been better off driving into Chile every time I wanted to make a call or get on the ‘Net.

Argentina’s collapse would resonate beyond its borders. Already, its economic woes have had a infectious affect on the economies of Brazil, Chile, and Mexico. While U.S. bank exposure to Argentina is only $12 billion, adding in Mexico and Brazil ups the ante to $54 billion. Many U.S. companies have investments in South America that would suffer or disappear.

It’s particularly a tragedy because Argentina is an incredible country. I came in through Chile and drove across the Andes Mountains into the Patagonia region, rugged terrain that challenges even the most seasoned traveler. Along the coast, we saw all sorts of animals sea lions and dolphins and penguins.

We drove 1,000 kilometers out of our way to see Perito Moreno, a glacier that is one of the most remarkable sights I’ve ever seen. My wife Paige thought it was crazy to drive so far to see a block of ice. She understood once we arrived.

The glacier is several hundred kilometers across, and juts back into the Andes. Ice breaks off, crackling like so many rounds of gunfire. The iceberg itself groans as if it’s alive.

And the people are extraordinary. With virtually no ethnic groups, about 85 percent of its population are of European ancestry. Argentina is one of the few places we visited where everyone spoke the same language –Spanish and everyone was white.

The food is extraordinary and the wines are some of the best we’ve had.

So why am I taking out my last remaining dollars?

Countries that get into trouble like this have a history of making it impossible to get at your money. I wouldn’t be surprised if the government doesn’t arbitrarily start telling people the dollars in their bank accounts are now pesos. Or maybe the government will tell us it is going to replace our dollars with peso-denominated bonds that pay out over 10 or 20 years.

Even with all that, I’m really getting out because of attitude. I don’t know if its hubris or ignorance but the people are not facing the reality of the situation. And until I get a sense that Argentina itself knows it has a problem, I’m taking my dollars if they aren’t pesos by now as far away as possible.