Argentina

According to some people, there is always an element of gamble involved when an investor buys a bond. Part of that gamble is that an upsurge in inflation will not consume the value of the bond’s annual interest payments. If inflation goes up to 10% and the value of a fixed rate interest is only 5, then that basically means that the bond holder is falling behind inflation by 5%. The danger that rising inflation poses is that it erodes the purchasing power of both the capital sum invested and the interest payments due. And that is why, at the first whiff of higher inflation, bond prices tend to fall. Even as recently as the 1970s, as inflation soared around the world, the bond market made a Nevada casino look like a pretty safe place to invest your money. US inflation surged into double digits, peaking at just under 15% in April 1980. That was very bond-unfriendly, and it produced… perhaps the worst bond bear market not just in memory but in history. To be precise, real annual returns on US government bonds in the 1970s were minus 3%, almost as bad as during the inflationary years of the world wars. Today, only a handful of countries have inflation rates above 10% and only one, Zimbabwe, is afflicted with hyperinflation. In March 2008, a funeral in Zimbabwe costs 1 billion Zimbabwean dollars. The annual inflation rate is 100,000%. But back in 1979, at least 7 countries had an annual inflation rate above 50% and more than 60 countries, including Britain and the US, had inflation in double digits. Among the countries worst affected, none suffered more severe long-term damage than Argentina.

Once, Argentina was a byword for prosperity. The country’s very name means the land of silver. The river on whose banks the capital Buenos Aires stand is the Rio de la Plata - in English, the silver River - a reference not to its color, which is muddy brown, but to the silver deposits supposed to lie upstream. In 1913, acccording to recent estimates, Argentina was one of the 10 richest countries in the world. Outside the English-speaking world, per capita gross domestic product was higher in only Switzerland, Belgium, the Netherlands and Denmark. Between 1870 and 1913, Argentina’s economy had grown faster than those of both the US and Germany. There was almost as much foreign capital invested there as in Canada. It is no coincidence that there were once two Harrods stores in the world: one in Knightsbridge, in London, the other on the Avenida Florida, in the heart of Buenos Aires. Argentina could credibly aspire to be the UK, if not the US, of the southern hemisphere. In February 1946, when the newly elected president General Juan Domingo Peron visited the central bank in Buenos Aires, he was astonished at what he saw. He marveled, ‘There is so much gold, you can hardly walk through the corridors’.

The economic history of Argentina in the 20th century is an object lesson that all the resources in the world can be set at nought by financial mismanagement. Particularly after the Second World War, the country consistently underperformed its neighbours and most of the rest of the world. For example, so miserable did it fare in the 1960s and 1970s that its per capita GDP was the same in 1988 as it had been in 1959. By 1998, it had sunk to 34% of the US level, compared with 72% in 1913. It had been overtaken by, among others, Singapore, Japan, Taiwan and South Korea - not forgetting, most painful of all, the country next door, Chile. What went wrong? One possible answer is inflation, which was in double digits between 1945 and 1952, between 1956 and 1968 and between 1970 and 1974; and in treble (or quadruple) digits between 1975 and 1990, peaking at an aannual rate of 5,000% in 1989. Another answer is debt default: Argentina let down foreign creditors in 1982, 1989, 2002 and 2004. Yet, these answers will not quite suffice. Argentina had suffered double-digit inflation in at least 80 years between 1870 and 1914. It had defaulted on its debts at least twice in the same period. To understand Argentina’s economic decline, it is once again necessary to see that inflation was a political as much as a monetary phenomenon.

An oligarchy of landowners had sought to base the country’s economy on agricultural exports to the English-speaking world, a model that failed comprehensively in the Depression. Large-scale immigration without (as in North America) the freeing of agricultural land for settlement had created a disproportionately large urban working class that was highly susceptible to populist mobilization. Repeated military interventions in politics, beginning with the coup that installed Jose F. Uriburu in 1930, paved the way for a new kind of quasi-fascistic politics under Peron, who seemed to offer something for everyone: better wages and conditions for workers and protective tariffs for industrialists. The anti-labor alternative to Peron, which was attempted between 1955 (when he was deposed) and 1966, relied on currency devaluation to try to reconcile the interests of agriculture and industry. Another military coup in 1966 promised technological modernization but instead delivered more devaluation, and higher inflation. Peron’s return in 1973 was a fiasco, coinciding as it did with the onset of a global upsurge in inflation. Annual inflation surged to 444%. Yet another military coup plunged Argentina into violence as the National Reorganization Process condemned thousands to arbitrary detention and ‘disappearance’. In economic terms, the junta achieved precisely nothing other than to saddle Argentina with a rapidly growing external debt, which by 1984 exceeded 60% of GDP (though this was less than half the peak level of indebtedness attained in the early 1900s). As so often in inflationary crises, war played a part: internally against supposed subversives, externally against Britain over the Falkland Islands. Yet it would be wrong to see this as yet another case of a defeated regime liquidating its debts through inflation. What made Argentina’s inflation so unmanageable was not war, but the constellation of social forces: the oligarchs, the caudillos, the producers’ interest groups and the trade unions - not forgetting the impoverished underclass or descamizados (literally the shirtless). To put it simply, there was no significant group with an interest in price stability. Owners of capital were attracted to deficits and devaluation; sellers of labor grew accustomed to a wage-price spiral. The gradual shift from financing government deficits domestically to financing them externally meant that bondholding was oursourced. It is against this background that the failure of successive plans for Argentine currency stabilization must be understood.

In his short story “The Garden of Forking Paths”, Argentina’s greatest writer Jorge Luis Borges imagined the writing of a Chinese sage, Tsui Pen:

In all fictional works, each time a man is confronted with several alternatives, he chooses one and eliminates the others; in the fiction of Tsui Pen, he chooses - simultaneously - all of them. He creates, in this way, diverse futures; diverse times which themselves also proliferate and fork… In the work of Tsui Pen, all possible outcomes occur; each one is the point of departure for other forkings… Tsui Pen did not believe in a uniform, absolute time. He believed in an infinite series of times, in a growing, dizzying net of divergent, convergent and parallel times.

This is not a bad metaphor for Argentine financial history in the past 30 years. Where Bernardo Grinspun attempted debt rescheduling and Keynesian demand management, Juan Sourrouille tried currency reform (the Austral Plan) along with wage and price controls. Neither was able to lead the critical interest groups down his own forking path. Public expenditure continued to exceed tax revenue; arguments for a premature end to wage and price controls prevailed; inflation resumed after only the most fleeting of stabilizations. The forking paths finally and calamitously reconverged in 1989: the annus mirabilis in Eastern Europe; the annus horribilis in Argentina.

In February 1989 Argentina was suffering one of the hottest summers on record. The electricity system in Buenos Aires struggled to cope. People grew accustomed to five-hour power cuts. Banks and foreign exchange houses were ordered to close as the government tried to prevent the currency’s exchange rate from collapsing. It failed: in the space of just a month the austral fell 140% against the dollar. At the same time, the World Bank froze lending to Argentina, saying that the government had failed to tackle its bloated public sector deficit. Private sector lenders were no more enthusiastic. Investors were hardly likely to buy bonds with the prospect that inflation would wipe out their real value within days. As fears grew that the central bank’s reserves were running out, bond prices plunged. There was only one option left for a desperate government: the printing press. But even that failed. On Friday 28 April Argentina literally ran out of money. ‘It’s a physical problem,’ Central Bank Vice-President Roberto Eilbaum told a news conference. The mint had literally run out of paper and the printers had gone on strike. ‘I don’t know how we’re going to do it, but the money has got to be there on Monday,’ he confessed.

By June, with the monthly inflation rate rising above 100 per cent, popular frustration was close to boiling point. Already in April customers in one Buenos Aires supermarket had overturned trolleys full of goods after the management announced over a loudspeaker that all prices would immediately be raised by 30%. For two days in June, crowds in Argentina’s second largest city, Rosario, ran amok in an eruption of rioting and looting that left at least fourteen people dead. However, as in the Weimar Republic, the principal losers of Argentina’s hyperinflation were not ordinary workers, who stood a better chance of matching price hikes with pay rises, but those reliant on incomes fixed in cash terms, like civil servants or academics on inflexible salaries, or pensioners living off the interest on their savings. And, as in 1920s Germany, the principal beneficiaries were those with large debts, which were effectively wiped out by inflation. Among those beneficiaries was the government itself, in so far as the money it owed was denominated in australes.

Yet not all Argentina’s debts could be got rid of so easily. By 1983 the country’s external debt, which was denominated in US dollars, stood at $46 billion, equivalent to around 40% of national output. No matter what happened to the Argentine currency, this dollar-denominated debt stayed the same. Indeed, it tended to grow as desperate governments borrowed yet more dollars. By 1989 the country’s external debt was over $65 billion. Over the next decade it would continue to grow until it reached $155 billion. Domestic creditors had already been mulcted by inflation. But only default could rid Argentina of its foreign debt burden. As we have seen, Argentina had gone down this road more than once before. In 1890 Baring Brothers had been brought to the brink of bankruptcy by its investments in Argentine securities (notably a failed issue of bonds for the Buenos Aires Water Supply and Drainage Company) when the Argentine government defaulted on its external debt. It was the Barings’ old rivals the Rothschilds who persuaded the British government to contribute £1 million towards what became a £17 million bailout fund, on the principle that the collapse of Barings would be ‘a terrific calamity for English commerce all over the world’. And it was also the first Lord Rothschild who chaired a committee of bankers set up to impose reform on the wayward Argentines. Future loans would be conditional on a currency reform that pegged the peso to gold by means of an independent and inflexible currency board. A century later, however, the Rothschilds were more interested in Argentine vineyards than in Argentine debt. It was the International Monetary Fund that had to perform the thankless task of trying to avert (or at least mitigate the effects of) an Argentine default. Once again the remedy was a currency board, this time pegging the currency to the dollar.

When the new peso convertible was introduced by Finance Minister Domingo Cavallo in 1991, it was the sixth Argentine currency in the space of a century. Yet this remedy, too, ended failure. True, by 1996 inflation had been brought down to zero; indeed, it turned negative in 1999. But unemployment stood at 15 per cent and income inequality was only marginally better than in Nigeria. Moreover, monetary stricture was never accompanied by fiscal stricture; public debt rose from 35 per cent of GDP at the end of 1994 to 64 per cent at the end of 2001 as central and provincial governments alike tapped the international bond market rather than balance their budgets. In short, despite pegging the currency and even slashing inflation, Cavallo had failed to change the underlying social and institutional drivers that had caused so many monetary crises in the past. The stage was set for yet another Argentine default, and yet another currency. After two bailouts in January ($15 billion) and May ($8 billion), the IMF declined to throw a third lifeline. On 23 December 2001, at the end of a year in which per capita GDP had declined by an agonizing 12 per cent, the government announced a moratorium on the entirety of its foreign debt, including bonds worth $81 billion: in nominal terms the biggest debt default in history.

The history of Argentina illustrates that

the bond market is less powerful than it might first appear.

The average 295 basis point spread between Argentine and British bonds in the 1880s scarcely compensated investors like the Barings for the risks they were running by investing in Argentina. In the same way, the average 664 basis point spread between Argentine and US bonds from 1998 to 2000 significantly underpriced the risk of default as the Cavallo currency peg began to crumble. When the default was announced, the spread rose to 5,500; by March 2002 it exceeded 7,000 basis points. After painfully protracted negotiations (there were 152 varieties of paper involved, denominated in six different currencies and governed by eight jurisdictions) the majority of approximately 500,000 creditors agreed to accept new bonds worth roughly 35 cents on the dollar, one of the most drastic “haircuts’ in the history of the bond market. So successful did Argentina’s default prove (economic growth has since surged while bond spreads are back in the 300-500 basis point range) that many economists were left to ponder why any sovereign debtor ever honours its commitments to foreign bondholders.”