Emma’s Note: In March, Bill and Elizabeth traveled to Argentina to spend a couple of weeks on their ranch there. The day after they arrived, the country went into lockdown.
Nine months later, they have finally made it back to the U.S. And they’re currently making the trip up the coast from Miami to Baltimore.
So this week, we’re revisiting some of Bill’s earlier essays. Today, he tells us the three key lessons he has learned from his years living in and doing business in Argentina.
SOMEWHERE BETWEEN MIAMI and BALTIMORE – I regularly spend time in dysfunctional economies.
In Argentina, if you want to buy something, you need to know which money the seller will accept… and at what rate.
“Do you want the white rate, the blue rate, or the black rate? Or do you want to pay in dollars?” comes the typical question.
To answer intelligently, you have to go into a “cave.” Yes, that’s what they call the “unofficial” money-changing places in Argentina.
After Mauricio Macri took office in 2015, the three rates – white, blue, and black – converged. Currency trading is legal now. But the dealers still do the trades, albeit with lower margins.
[Since this was originally written, another election has returned Cristina Kirchner to power. Now, there are the three different rates again.]
In Salta, the nearest city to the ranch, the currency traders are still on the corner of the central plaza… where they ask for dolares from passing tourists. But the major clients are probably not passing tourists at all.
Every so often, a pickup truck stops. A window comes down.
“What’s the rate?” the driver asks.
The changer approaches the window and makes his best offer. If the driver is satisfied, he pulls out a wad of bills.
The tourists want pesos – at a good rate, so they can buy things in Salta. But the locals want dollars – so they can protect themselves against inflation that has been running at a rate believed to be about 50% per year. (I say “believed to be” because nobody really knows… a point to which I will return later.)
But who knows how much longer that will last? Argentina is said to be running out of foreign exchange.
Dysfunctional System
Meanwhile, “off the books” – untaxed, unregulated, and often downright crooked – becomes a habit that is hard to break.
In a dysfunctional economy, every decision is complicated. Prices for imported machinery – not to mention everyday consumables – tend to be high. Protectionist legislation drives up costs. Officials need payoffs. Everybody needs to do all they can to bring down costs – using means that are legal, illegal, or often in between.
Uncertainty and ambiguity shadow every transaction. The uncertainty is deepened because both buyer and seller are also making bets on the real present value of the currency in which they are doing business… and its future value, too.
One of the hallmarks of such an economy is distrust. You never know what money you can trust… or whom you can trust. You never know exactly what is going on. And everything is subject to change.
What can we learn from Argentina? Can it help us prepare ourselves – and our families – for a more dysfunctional system in the U.S. and Europe? Perhaps.
Something’s Got to Give
For nearly half a century in the U.S., asset values, standards of living, and our GDP growth have depended on neither real output nor real earnings.
Instead, credit has expanded above and beyond the output needed to support it. Since roughly the beginning of the 1980s, debt has grown by in excess of $35 trillion more than corresponding GDP.
Sooner or later, something has to give; debt cannot increase faster than economic growth forever.
There is a strong likelihood that when the valve blows, America’s finances will seem as dysfunctional as those in Argentina.
Lessons from the Pampas
So what can we learn from Argentina that might help us?
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You can never believe the government’s numbers
In Argentina, for years, the official inflation rate was clocked at only 10% or less. Everyone knew that real consumer prices were going up at least 20-30% per year.
The government tried to hide the truth by rigging its Big Mac Index – the quick and dirty measure of purchasing-power parity favored by The Economist.
The Argentine feds strong-armed McDonald’s into holding the price of its signature hamburger down. McDonald’s had to withdraw the sandwich from the menu, since it lost money on each one, while the government insisted the burger had not gone up more than 10%.
Meanwhile, pizzas – a favorite fast food – were going up 25% per year. Locals began to refer to “The Pizza Index” for a truer measure of consumer price inflation.
In the U.S., once gold was dropped as a monetary discipline, there was no way to control money supply, credit… or inflation.
Economists tell us we have nothing to worry about because money supply and consumer inflation are under control. They are wrong. The numbers are fishy, and they miss the point.
You can find almost any inflation number you want – depending on the assumptions you make.
And money supply? The nature of money has changed. With it, the importance of the money supply has declined.
Gold was muscled out of the way in 1968, when the Johnson administration ended the requirement for the Federal Reserve to hold gold reserves against Federal Reserve notes. It was finally taken out the back and shot in 1971, when President Nixon ended direct convertibility.
Credit took its place.
The money supply (M2) has gone up around 7% per year since then. But Federal Reserve Bank Credit has risen much faster. People no longer have much “money,” in the old-fashioned sense. They have little in savings. And what they do save is not real money – it is a short-term debt instrument issued by the central bank.
Today, when people go to buy a house, a car, or even a three-course dinner… they do not use cash. Instead, they use credit.
What matters to them is not how much money they have, but how much credit they have available… and whether they have the cash flow to keep up with their mounting debt-service costs.
Their buying power depends on the continued supply of credit.
Inflation expectations, too, no longer depend on the money supply, but on the availability of credit and the public’s readiness to use it.
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Watch out for paper assets of all sorts
At the end of the 1990s, as a major financial crisis in Argentina approached, people tried to protect themselves by hoarding cash. Some kept pesos. Some kept U.S. dollars. Some kept bonds. Some kept pensions.
All of these paper savings and investments proved disastrous.
The peso was cut loose from the dollar. This caused the peso to fall by 65%.
Dollar deposits were no protection; the government merely closed the banks and converted dollar deposits into pesos. Same losses.
Pensions and bonds were marked down similarly… or the companies went out of business for 100% losses.
Later, private pensions were taken over by the government (supposedly for the purpose of protecting retirement funds). The government used the private pension funds to buy its own bonds.
Lesson: Paper assets can be too easily manipulated and devalued.
The result of this was devastating to the middle-class savers who counted on them. Many were wiped out. At the peak of the crisis, many former middle-class families were forced to dig through trash cans just to find something to eat.
The rich, meanwhile, were shrewder. They kept much of their money in foreign accounts – especially in Uruguay and Miami. And they bought real estate, businesses, and collectibles, instead of paper assets.
These tangible assets also fell in value in the crisis. But most recovered in the years following.
For example, I first came to Argentina in 2004. Then, prices for farms, ranches, and apartments seemed absurdly cheap. Since then, prices for real estate have risen substantially.
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Beware of a breakdown in trust
When an economy becomes dysfunctional, trust at every level declines. Novelist and journalist Stefan Zweig wrote about his own experiences in Germany and Austria during the 1920s:
The mark plunged down, never to stop until it had reached the fantastic figures of madness – the millions, the billions and trillions. Now the real witches’ sabbath of inflation started, against which our Austrian inflation with its absurd enough ratio of 15,000 old to 1 of new currency had been shabby child’s play.
To describe it in detail, with its incredibilities, would take a whole book. To readers of today it would seem like a fairy tale. I have known days when I had to pay fifty thousand marks for a newspaper in the morning and a hundred thousand in the evening; whoever had foreign currency to exchange did so from hour to hour, because at four o’clock he would get a better rate than at three, and at five o’clock he would get much more than he had got an hour earlier. For instance, I sent a manuscript to my publisher on which I had worked for a year; to be on the safe side I asked for an advance payment of royalties on ten thousand copies. By the time the check was deposited, it hardly paid the postage I had put on the parcel a week before.
On street cars one paid in millions, trucks carried the paper money from the Reichsbank to the other banks, and a fortnight later one found hundred thousand mark notes in the gutter; a beggar had thrown them away contemptuously. A pair of shoe laces cost more than a shoe had once cost; no, more than a fashionable shoe store with two thousand pairs of shoes had cost before; to repair a broken window cost more than the whole house had formerly cost, a book more than the printer’s shop with a hundred presses.
For $100 one could buy rows of six-story houses on the Kurfürstendamm, and factories were to be had for the old equivalent of a wheelbarrow. Some adolescent boys who had found a case of soap forgotten in the harbor disported themselves for months in cars and lived like kings, selling a cake every day, while their parents, formerly well-to-do, slunk about like beggars. Messenger boys established foreign-exchange businesses and speculated in currencies of all lands.
Towering over all of them was the gigantic figure of the super-profiteer Stinnes. Expanding his credit and exploiting the mark, he bought whatever was for sale, coal mines and ships, factories and stocks, castles and country estates, actually for nothing because every payment, every promise became equal to naught.
Soon a quarter of Germany was in his hands, and perversely, the masses, who in Germany always become intoxicated at a success that they can see with their eyes, cheered him as a genius. The unemployed stood around by the thousands and shook their fists at the profiteers and foreigners in their luxurious cars who bought whole rows of streets like a box of matches; everyone who could read and write traded, speculated, and profited and had a secret sense that they were deceiving themselves and were being deceived by a hidden force which brought about this chaos deliberately in order to liberate the State from its debts and obligations.
Firsthand observers called it a “hellish carnival,” where all the old standards of value, right and wrong, and good and evil were swept away. A man saved all his life so he could enjoy a decent retirement. In a week, all his savings might have been devalued to zero.
Did that mean his entire life was worthless? There seemed to be no reason to prepare for the future… no reason for self-discipline or self-denial… no reason to hold back. No one knew what anything was worth… neither material object, nor custom, nor a promise. The effect was, according to some observers, maddening.
When the Big Break Comes
We don’t know what to expect in the U.S… or when to expect it. As in Japan, things could go on like this – with rising debt levels and a fairly stable economy – for many years.
But when the big break comes, trust in the old model… its money, its promises, its theories, and its ways of doing business… will all dissolve.
People will not be able to identify the culprit, exactly. Instead, they will merely feel cheated… and many will feel as though they have to cheat, too. Loans, business commitments, paperwork of all sorts – all become unreliable and untrustworthy. Contracts, bills, receipts – often, they are simply made up.
People tend to cheat in many different ways. Offshore bank accounts become common… with many transactions made through secret accounts… and many purchases and sales made in cash and “under the table.”
In business, investments, and government, trust will decline quickly. And the typical American won’t be prepared. He will learn – at considerable expense – to diversify into other currencies, gold, real estate, and real assets… to distrust official numbers… and to be prepared to ignore fishy statistics and slippery transactions of all sorts.
When this happens, that’s when the experience of doing business in Argentina may finally pay off.
Regards,
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Bill
P.S. Inflation is one of the biggest threats we face over the next 10 years. If the record expansion in the money supply (M2) leaks into consumer prices, the social contract – and civilization itself – will break down. You need to act now to protect your wealth.
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