North America

Why the USA is like Argentina (2015 update)

Pesification

This is an update of an article that originally appeared in OfWealth in July 2013.

The USA and Argentina are both big countries – 4th and 8th largest in the world. It’s well know that both have vast expanses of rich farmland. And both are famous for their cattle herders, whether they are “cowboys” or “gauchos”. But what is less understood is that their public finances have some are worryingly similar features. This is why the USA is like Argentina.

Argentina is infamous in the history of financial crises. Hyperinflations, devaluations, debt defaults, banking crises. You name it and the Argentines have probably been through it in the past half century. The last meltdown was in 2002. The currency collapsed, dollar bank deposits were “pesified” (converted to pesos by government dictat), rioters were burning tyres in the streets and shooting at the shuttered entrances of the banks.

Argentine politicians are renowned for their populist short-termism, desire to fight market forces, and consistent belief that they can reinvent the laws of economics. And for their apparently short memories…

…the average taxi driver in Buenos Aires understands more about financial mismanagement than the crowd at a conference of nobel prize winning economists and central bankers.

As a result, the average taxi driver in Buenos Aires understands more about financial mismanagement than the crowd at a conference of nobel prize winning economists and central bankers.

The USA is still the world’s largest economy – measured at market exchange rates – and issues the world’s main reserve currency, the US dollar. The US capital markets for stocks (shares) and bonds are the biggest and most liquid (easily traded) in the world. The country is seen as being advanced in all things financial. And yet there are surprising similarities with the way that Argentina runs its finances these days. In fact in some ways the US is even worse.

Argentina has reached a record total public debt equivalent to US$204 billion, ultimately owed by a population of 41.4 million people. By comparison the US has a national debt of US$18,609 billion (US$18.6 trillion) according to the US National Debt Clock, and a population of 318.9 million.

(Editor’s note: The US national debt increased by a massive US$1.9 trillion, or 11%, in the 28 months since OfWealth published the first version of this article, in July 2013.)

That means debt per capita is about US$5,000 in Argentina and US$58,000 in the US. That compares with GDP per capita of about US$13,300 in Argentina and US$56,400 in the USA.

Conclusion #1: Individual Americans owe almost 12 times as much government debt per capita as individual Argentines. But US GDP per capita is only 4.3 times as much.  Now who’s government looks irresponsible?

Bloomberg has previously reported that 58% of the Argentine debt is owned by public institutions, including the central bank (Banco Central de la Republica Argentina, or BCRA), the state pension fund (ANSES), state owned Banco de la Nacion Argentina, amongst others.

The typical smoke and mirrors of the modern age. Fiddling the books to keep political vanity projects on the go and to buy votes.

In other words, the Argentine government owes itself a huge amount of its own debt. It’s just a money-go-round. The typical smoke and mirrors of the modern age. Fiddling the books to keep political vanity projects on the go and to buy votes.

This is done by dipping into foreign exchange reserves at the central bank and money held by the state pension fund to cover day-to-day, and rapidly expanding, government spending. Quite rightly this is something to be concerned about, as the money is drained away and wasted on buying votes.

In 2014, Argentina had a budget deficit of 2.5% of GDP, meaning the government spent more than it received in tax receipts. The USA had a similar, although slightly larger deficit of 2.8% of GDP (although down from 9.8% in 2009).

Yet again the USA isn’t so different to Argentina. Apart from running a big deficit, and piling on more and more debt, the USA did something called quantitative easing (“QE”) between November 2008 and October 2014. It may yet do more.

QE is the process where the central bank (Federal Reserve, “Fed”) creates brand new money with a computer stroke and uses it to buy mainly government bonds, known as US Treasury bonds in the US, or “treasuries” for short.

This caused an explosion in the amount of the tradable government debt held by the Fed. Added to the smaller amounts held by state and local governments it comes to 20% of the total US federal government debt, or $3.7 trillion.

On top of that there is the “intra-governmental debt”, which is just shy of $4.7 trillion. This is mainly “owned” by public pension and insurance funds such as the Social Security Trust Fund ($2.7 trillion) and pension funds for public employees. Contributors to these funds – which include all private and public sector employees – make cash payments into them each month. The money is then handed over to the federal government and spent, in return for a debt owed to the funds.

Add together all these government holdings and you get a figure of $8.4 trillion. That’s 45% of total US government debt that is owned by public institutions. It’s really not all that different to the 58% equivalent figure in Argentina. It’s certainly not what most people would expect when they compare the public finances of those two countries.

Conclusion #2: both the Argentine and US governments raid their central banks and public pension funds to cover their excessive public spending.

Price inflation probably isn’t that different between the countries either – at least when measured in US dollars. Few people, except perhaps the truly stupid or insane, trust Argentine pesos to preserve their purchasing power. (The outgoing, populist Argentine president, Cristina Fernandez de Kirchner, has claimed she keeps all her savings in pesos. You can draw your own judgements from that claim…)

The dollar may be imperfect but the peso is positively impure…

Dollars are important in Argentina. In fact US government bodies estimate that Argentines hold one in every 15 of the physical dollars in circulation in the entire world. The dollar may be imperfect but the peso is positively impure…

Official price inflation in Argentina is reported to be around 14% over the past year. But it is widely known that the government fixes the figure. Independent estimates released by opposition members of the congress put inflation at 25% in the year to October 2015, based on figures calculated by private consultancies.

This high inflation is because the central bank is printing money at a rapid rate – often quite literally. Total money supply increased by a third over the past year, and the value of physical notes in circulation is also up by 30%. Perhaps it’s no surprise that the two biggest movers of cash notes in Argentina – Brink’s Co. and Prosegur Cia de Seguridad SA – both had excellent third quarter earnings. Their armoured trucks have been in high demand.

This is because 100 peso bills – the largest denomination of physical cash – are only worth US$10.50 at the artificially managed official exchange rate. On the black market – at the so-called “dolar blue” rate – 100 peso notes only worth US$6.69. With the government set to change in December, there are hopes that higher denomination bills will be introduced.

It’s interesting that at a time when many are predicting an end to physical cash in developed countries (an opinion that we disagree with), paper money remains essential to the Argentine economy. Huge amounts of business are transacted using physical cash, not least due to its benefit of being anonymous in a country prone to authoritarian governments.

The peso has lost a lot of value against the dollar due to the government’s money printing. In fact since mid-2008 it has lost 80%, using unofficial (ie market) rates.

Just over the past 12 months the peso fell to being worth just 83% as many dollars (or cents). That means Argentine prices, when measured in US dollars, rose a much lower 3.8% over the year (1.25 x 83% = 1.038).

In the meantime, official consumer price inflation (CPI) in the US was running at 0% at the end of October, for the previous year. But, just like in Argentina, this figure is almost certainly understated by the government.

Shadowstats, a consultancy, reckons US inflation was 3.5% using the previous government methodology from 1990, and 7.5% using the methodology from 1980 – before the US government started manipulating the figures so aggressively. Also, stripping out the temporary effect of the collapsing oil and other commodity prices, even the official figure is much higher. CPI excluding food and energy was 1.9%.

Conclusion #3: It’s a fair bet that dollar price inflation in Argentina and the USA is pretty similar – at around 3% give or take a percentage point or two.

Why the USA is like Argentina

So there you go. There are some surprising similarities between the finances of the USA and Argentina. Both governments owe themselves a huge amount of their own debt – ultimately leaving their central banks and pensioners in weaker positions. Both under report their official inflation figures. And in at least one way – the debt per person – the USA looks much worse.

That’s not to say that the USA is likely to have an Argentine-style financial crisis any time soon. At least I hope it won’t – not least for the sake of all those Argentines that own dollar bills as protection from their own government’s economic mismanagement.

But it pays to remind ourselves that it’s not just down on the pampas that public finances are being mismanaged. After all, Argentina was one of the richest countries in the world less than 100 years ago. But decades of misrule under various despots and populist demagogues put paid to Argentina’s wealth.

When viewed from afar, US politics – as embodied in the seemingly never ending presidential race  – appears to be descending into populist farce as well.

Will the USA still be rich in 100 years time? Or even in 50 years? Given the country’s huge debts, can we even call it rich now? The US, and most other “rich” developed economies, look like they are heading the way of Argentina.

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.