Latin America

Argentina: great opportunity or up the creek?

On Sunday 22nd November the Argentine people elected a new government, by a narrow margin. The incoming president is expected, at the very least, to be far less incompetent than the outgoing populist. But he inherits a country that’s up an economic creek, yet finds itself with a distinct shortage of financial paddles. This means it’s still too early to invest in Argentina.

Argentina is living through the dying days of kirchnerismo. This is the current populist brand of peronism, named after Juan Peron, who first became president of Argentina in 1952.

Peronism is an incoherent sort of political philosophy, with both right and left wings and an unfortunate leaning towards authoritarianism.

Peronism is an incoherent sort of political philosophy, with both right and left wings and an unfortunate leaning towards authoritarianism. After all, its eponymous founder was inspired by the Italian inventor of fascism, Benito Mussolini.

It claims to fight for the workers and social “justice”, but typically achieves the opposite: financial crises and the poverty that ensues. Except, of course, for its leaders. They invariably pocket oodles of ill gotten gains, reaped during their time in office.

Peronism is a uniquely Argentine disease, with the latest strain named after its most recent protagonists: Nestor Kirchner and his wife Cristina Fernandez de Kirchner. Nestor was president from 2003 to 2007 before handing the reins of power – at least formally – to his wife Cristina.

If there was an Oscar awarded for Best Actor in a Foreign Political Monologue she would win hands down. She can waffle on for hours – and often does – turning the tears on and off at will, and beseeching her brainwashed minions to think that she does it all for love. You’ve got to hand it to her – it has certainly worked. But it’s a sad reminder of how easy it is to make people dance to the demagogue’s tune.

After reaching her constitutional limit of two terms in office, “CFK” will finally bid farewell to the casa rosada (the presidential palace) on 10th December. Her chosen successor, Daniel Scioli, finds himself without a job.

In keeping with the finest peronist traditions, Cristina will leave the country in a poor economic and financial condition. She may even literally leave the country – with her bags stuffed to bursting with cash. Her replacement, Mauricio Macri, now faces the huge challenge of picking up the pieces.

Macri and Scioli had a tight race, amidst much mud slinging. In the end Macri won by less than 3 percentage points, which is not exactly a huge mandate. His opposition coalition has a minority in both the senate and congress, which will make it difficult to negotiate the tough changes that Argentina needs.

Nestor Kirchner came to power at a time that made it easy to look competent. Argentina had just had a huge financial crisis, resulting in a massive debt default and currency devaluation.

All he had to do was ride the bounce out of depression and he’d come up smelling of roses, aided by booming global commodity markets at the time. Half or more of Argentina’s exports – and therefore source of dollar earnings – come from agriculture. Soybeans, wheat, maize (corn), beef and so on.

But politicians are rarely known to waste an opportunity to screw things up, much less populist ones of the type that Latin America is so fond.

But politicians are rarely known to waste an opportunity to screw things up, much less populist ones of the type that Latin America is so fond. Both of the Kirchners have followed policies that have steadily driven Argentina back to the brink.

Fortunately the country has remained locked out of international bond markets since the debt default, due to a long running legal dispute with some US hedge funds – known as the “vulture funds” in Argentina (and deservedly so). Although the situation is bad, at least there is little foreign debt to default on this time around. But there are still big issues.

The root of the problems come from rampant money printing used to fund government spending that’s been used, in turn, to buy votes. Perhaps the most blatant populist policy has been the huge amounts of public money spent on “football for everyone”. (Meaning soccer – perhaps Cristina admires the players’ acting skills.)

This provides free coverage of big games on a public TV channel, with plenty of government propaganda during the breaks. It’s pretty odd to prioritise free sports coverage in a country with often dilapidated schools, hospitals, roads and railways. That’s pure populism.

The boom in government spending and money printing are both highly inflationary. The 2015 budget deficit is estimated at around 7% of GDP by the likes of investment bank Goldman Sachs. Consumer price inflation was 35-40% in 2014 and around 25% this year, according to private estimates.

In both cases these figures – deficit and inflation – are twice or more the official government statistics. The government motto appears to be: “If at first you don’t succeed, lie, lie and lie again”. (Mind you, that’s not unique to Argentina, just less subtly put into practice there.)

Instead of dealing with the underlying causes of problems, the government has used short term fixes, which themselves have made the problems worse.

The result is ever more extreme interventions into the economy and markets to preserve the illusion of stability for just a little bit longer. These have included price controls on food and energy, massive export taxes on agricultural products, tight restrictions and high taxes on imports, currency controls that make it hard to buy dollars legally…and so on, and so on.

Generally los K have done anything you could think of to patch things over. Just so long as they haven’t had to cut off the torrent of funds that’s been gushing into the laps of government insiders and their pet peons.

But now they’ve run out of road. The country is suffering a severe stagflation – a stagnant economy and high price inflation. So it’s time to make it someone else’s problem. That way, if things don’t work out, the newbies can take the blame.

One of president elect Macri’s biggest problems is that the central bank’s coffers have run dry. Officially, Argentina has foreign exchange reserves of US$26.2 billion. But a post-election analysis by local newspaper La Nacion puts the figure at just US$424 million. Barclays, an investment bank, puts the figure at US$2 billion, which is still tiny.

Argentine-Reserves

This is because almost all the supposed reserves are already committed to paying off debts, or belong to someone else, or simply aren’t liquid. In other words they can’t be used, which makes them worthless.

As a sign of desperation, commercial banks have been ordered to sell some of their dollar assets to the central bank. Presumably this is so the central bank can keep wasting money on propping up the Argentine peso, right up until the moment in two weeks’ time when Cristina’s backside has vacated the throne.

Argentina desperately needs dollars, and fast.

The reserve numbers have been fudged with accounting sleight of hand. But now that there is a new government in waiting the real situation is leaking out. Argentina desperately needs dollars, and fast.

Macri also wants to roll back restrictions in the currency market. These have resulted in a mind-numbing mess of different exchange rates used for various activities – whether legal or deemed otherwise.

On one underground web site I counted no less than 12 different exchange rates between the peso and the dollar. The main ones are the official rate (which exporters and importers are forced to use)…the rate at which Argentines can legally buy modest amounts of dollars (official plus 20%)…the rate for making foreign purchases on credit cards (official plus 35%)…the rate for legally trading Argentine stocks and bonds between their dollar price in New York and their peso price in Argentina (currently 46% above official)…and the black market rate for cash transactions on the street (currently 56% above official).

It’s a wonder how Argentines can keep up with it all. And no wonder that many thought the country could head the way of Venezuela – with its even higher inflation, even more broken economy, and even bigger difference between official and black market exchange rates.

The official exchange rate is heavily propped up by central bank intervention, plus forced buying of peso assets by public pension funds and commercial banks. The outgoing government doesn’t want to be seen to devalue before it leaves office.

Never mind that even the official rate has already lost two thirds of its value against the US dollar over the past five years (rate from 3.15 pesos per dollar to 9.64). If that isn’t a devaluation then I don’t know what is.

Macri has said he wants to lift the restrictions and get back to one exchange rate for everything. Current expectations are for a devaluation from 9.64 pesos per dollar to something more in line with the market rates (13 to 15 to the dollar).

As always, the market has already won in the fight against irrational government intervention. Macri just needs to make it official.

His government also needs to tame inflation, drastically cut the budget deficit, cut taxes on agricultural exports, remove restrictions on imports and quickly bring some dollars into the country. It’s going to be tough to get the sequence right without making things worse.

As for the Argentine stock market I can’t even tell you whether it’s cheap or expensive. Measured in pesos it’s gone up 236% in the past five years. Using manipulated official exchange rates it’s up 38% in US dollar terms. But using black market rates – which foreshadow the coming reality – it’s down 9% in dollars.

Up in pesos, but down in dollars

(Argentine BURCAP index, past five years)

Burcap

There is so much noise in the data – with the multiple exchange rates and raging inflation – that’s it’s practically impossible to make head or tail of it. One source I found says the stock market index trades with a P/E of 8, another says it’s 24.

The former is a tentative buy signal, the latter is a clear sell signal. More clarity is needed. At the very least, an official devaluation will most likely lead to a falling market in US dollar terms. After the event things could start to get interesting.

In the short term, Argentina’s economic and financial challenges are huge. Beyond that, the change to a more pragmatic and business friendly government could certainly spell a new dawn for Argentina. But there’s a lot of mess to sort out first.

Argentine stocks should be on your watch list. However, until it becomes clearer whether the country’s challenges can be addressed, it’s still far too early to pile in.

There will be plenty of time later to sail up the rio de la plata. For now Argentina finds itself up a creek…and paddles are in short supply.

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.