The Greater Depression

With a shaky global economy, a plunging dollar and deflation casting its dark shadow into many corners, there are nonetheless some encouraging signs of revival in the U.S. stock market. Yet, it cannot be denied, we are living in one of the more challenging periods for investors in many decades. During the first few days of June, I spent some time trying to get an added perspective from about as far from Wall Street as you can get…in Buenos Aires. My journey was the first I have taken to Argentina since it slipped into a devaluation crisis and a ‘Greater Depression’ in January 2002. I wanted to see first-hand how people there were coping with an economic collapse even more severe than the United States suffered in the Great Depression. In 2002 alone, the average income in Argentina plunged by 40%.

The economic history of Argentina provides cautionary evidence that wealthy countries can rapidly fall to Third World income levels. This may be more pertinent than it first appears because the collapse in Argentina occurred very rapidly, within the span of one long human lifetime. Even if you have never thought you had any interest in Argentina, stay tuned.

If you’ve never been to Argentina, I recommend the trip. Buenos Aires is a beautiful, cosmopolitan city, the most European in South America, with lots of Belle Epoque buildings, and broad avenues lined with cafes, trendy boutiques and bookshops. Unless you are blinded by ‘political correctness,’ you are bound to notice after a few hours that everyone you see is of European descent.

Argentine Economy: An Italian Speaking Spanish…

Argentina’s demographic mix was frozen generations ago when it ceased to be one of the world’s more dynamic economies. As Argentina stagnated, it became unattractive as a destination for later waves of ambitious immigrants from Africa, the Middle East and Asia. A common caricature of an Argentine captures this Western European heritage: "An Argentine is an Italian speaking Spanish who believes he is an Englishman living in Paris."

In 1950, Argentina was more than twice as rich as Japan on a per-capita basis. By 1970, the Japanese had caught up and were 30% richer than Argentines. But while Argentina’s economy contracted at an almost 2% annual rate, Japan’s soared ahead. By 1990, when the Japanese bubble burst, Japan was almost three times richer than Argentina on a per-capita basis, reversing the situation at the eve of World War I, when Argentines were on average almost three times richer than the Japanese. In three quarters of a century, Argentines failed to even double their incomes, while the Japanese multiplied their per-capita incomes by almost 14-fold.

Many economists believe the negligible population growth in Argentina through most of the last half-century contributed to its weak economic performance prior to the 1990s. Per- capita economic growth was negative from 1970 to 1990. A contracting economy tends not to attract immigrants, which makes the economy weaker still.

If Argentine history is any indication, frequently voiced worries about massive defaults on consumer credit card debt in North America are probably overstated. Notwithstanding the fact that poverty rates in Argentina have soared beyond anything imaginable in North America, given last year’s 40% plunge in per-capita income, credit card debt is the only valuable asset left in Argentina’s banking system.

Argentine Economy: Confiscatory Policies

Business borrowing has come to a halt. Even companies that are losing money are hoarding piles of cash. The government has defaulted on its debt, wiping out pension programs that held 70% of their assets in government bonds, and depriving the banking system of what is usually one of its strongest assets. The mortgage market has been devastated by the fall of personal income, which means that most people who would need a mortgage to buy a home can’t qualify. Yet Visa and MasterCard accounts are still being paid. Amazing.

A review of the confiscatory policies instituted by the last four Argentine presidents reads like the driving record of an alcoholic with a heavy foot. The last half- century has witnessed one gaudy crackup after another. The most recent, in January of last year, involved the abandonment of the currency board, which had successfully pegged the Argentine peso to the U.S. dollar for eight years. Because the currency board system really made the peso worth a dollar, it flatly prohibited the Argentine government from printing money.

Contrary to the superficial impressions of some critics, however, the currency board did not fail. It could have continued to peg the peso to the dollar indefinitely. It was abandoned because of ideological conviction. A large number of economists – and others meddlers such as former U.S. Treasury Secretary Paul O’Neill – loudly complained to Argentine authorities that sound money was hampering their economy. The local political establishment eagerly grasped the advice to return to easy money as a tonic for weak exports, unemployment and the unfairness of life. But contrary to expectations, the economy did not prosper. Real wages plunged by 40% following the devaluation. And the official poverty rate, which had seemed high at 38.5% in December 2001, skyrocketed to 58.5%. Ouch.

The experts were wrong. They had forgotten the history of Argentine political dysfunction, impressed cruelly on the Argentine population in the second half of the 20th century. These include the most disastrous peace-time inflation in all of modern history – an annual average inflation rate of 127% between 1960 and 1994. Unless you have an instinctive facility for compounding interest and the numerical gifts of an astrophysicist, you may not immediately grasp how devastating an annual average inflation of 127% is over 34 years. To put it in better perspective, consider that an Argentine with a fortune of $1 billion in 1960 who kept his savings in pesos through 1994 would have the equivalent of 1/13th of a penny left.


How did a wealthy country careen to such a disaster? That is an important puzzle if you have money to invest or expect to have it in your lifetime. I can’t pretend to be more than a voyeur where the history of Argentina is concerned. Still, I have my theories. I see the repeated crackup of the Argentine economy and its long-term decline from the ranks of the world’s richest countries as the unintended consequences of continuing efforts at income redistribution.

Argentine Economy: Subsidizing the Underachievers

You will note that income redistribution is hardly an Argentine invention. The United States and all the high- income economies have democratic political processes that guarantee gestures at subsidizing the underachievers. The logic is simple. Votes are equally distributed. Money and the other good things of life are not. Hence, the vivid appeal of income redistribution. But the question remains, why did these policies have so much more disastrous consequences in Argentina than apparently similar programs elsewhere?

I suspect that the answer may lie with the peculiar fact that there were relatively more rich people in Argentina than in the United States or Canada, but fewer in the middle class in the mid-19th century. Unlike the United States or Canada, Argentina does not have a strong tradition of yeoman farming. And not because of a lack of fertile land. The Argentine Pampas, an area 50% larger than France, contains some of the most marvelously fertile farmland on earth. Even today there are places in the Pampas where the topsoil is 10-feet deep. Little wonder Argentina was once known as "the world’s bakery." Yet unlike North America, where land suitable for cereal farming was divided into small plots, land tenure in the vast Argentine Pampas was concentrated into larger holdings that predated the Argentine Republic.

A century ago, it was not modernist irony to say that someone was ‘as rich as an Argentine.’ Lots of Argentines were rich. You can divide an area 50% larger than France into quite a few large holdings. Consequently, by the late 19th century the rich in Argentina were a relatively numerous group, far larger, for example, than the percentage of Americans who became industrial tycoons like Rockefeller or Carnegie.

I have no doubt that it is preferable in political terms to have a larger middle class than Argentina had when the 20th century began. In 1900, per-capita income in Argentina and Canada were at an equal level, as they had been since 1870. Both were not far below the United States. As you will probably remember from your history studies, most Western democracies initially had limited franchise, which restricted the ballot to property owners. So long as the franchise was limited in Argentina, the elected governments followed sound, free-market policies, and Argentine per- capita income rose smartly. Indeed, the growth of Argentina’s economy accelerated in the early years of the 20th century, rising 37.8% in real terms from 1900 to 1913. Notwithstanding unequal capital holdings, free-market policies raised Argentine per-capita income by more in the first 13 years of the 20th century than statist policies of income redistribution did in the 53-year period since 1950.

What can you learn from Argentina’s experience? Probably the most urgent lesson is that while a larger middle class may be politically stabilizing and desirable, it does not follow that efforts to artificially enlarge the middle class through income redistribution are economically stabilizing and desirable. Indeed, the record shows that Argentina’s economic crashes have been repeatedly occasioned by political efforts to cultivate and subsidize a bigger middle class.

More lessons to come, tomorrow…


James Davidson,
for The Daily Reckoning
July 1, 2003


"Tech jobs move offshore," says an indignant headline from Atlanta.

American policymakers are perfectly content with the division of labor in the world economy: the rest of the world makes, America takes. Other countries create jobs, profits, and products; the U.S. creates dollars with which to pay for them. Foreigners export cars and big-screen TVs; Americans export money and jobs. This is what makes America the richest country in the world, explained a half-mad economist recently, because wealth is measured by how much you consume, not how much you earn!

There you have it, dear reader: the road to wealth. Just turn left down Spendthrift Lane…then left again down Insolvency Drive…and then a final left on the Road to Ruin.

Live beyond your means. Spend more than you can afford. Consume more than you produce. Those of us who have no printing press with which to produce more dollars would find it hard to do for very long. We would soon run out of highway…and have to back up. We’d have to cut back on spending and pay down our debts. But the Dollar Standard System has allowed the U.S. to keep at it for an entire generation. That very same generation now approaches retirement – fat and sassy, and convinced that it can make it all the way to the grave on the savings of foreigners.

Egged on by deviant economists, they have come to believe that foreigners have no choice but to buy U.S. stocks and bonds…and that the flow of foreign savings to U.S. assets demonstrates not weakness in U.S system, but strength. Foreigners set up factories, create jobs, produce valuable goods, and earn profits…what else can they do but lend the money back to their own customers? Besides, everybody knows that the U.S. economy is the best in the world. Isn’t the current account deficit a measure of their admiration?

But something is going wrong. The central pillar of the whole system – the dollar – wobbles. Foreigners may be willing to buy U.S. treasury bonds, or they may not…but nothing guarantees that they will buy them at 1.15 euros to the dollar…or at the lowest yields in nearly 50 years.

When the foreigners figure out what Bernanke & crew aim to do to the dollar, their admiration could turn into contempt. They may not abandon the dollar altogether, but they will almost certainly want an additional point or two of interest – just in case. And that little nudge upward in the cost of money could have a devastating effect on the U.S. housing market…and the entire U.S. economy. All of a sudden, a generation of big spenders will find themselves at the end of the line…with nowhere else to go but back.

In the meantime, here’s Eric Fry with the latest news:


Eric Fry in Manhattan…

– The Dow dipped 4 points yesterday to 8,985, after rising as much as 79 points earlier in the session. And just like that, the final curtain fell yesterday on Wall Street’s best quarterly performance in more than four years. What a performance it was! Year-to-date, the Dow has added 7.7%, while the Nasdaq Composite Index has jumped a breathtaking 22%.

– How about a round of applause for the best darn bear market rally since the bear market began? But let’s also reserve a bit of applause for the lumpeninvestoriat, whose faithful sponsorship of the Wall Street performing arts made it all possible. If the lumps hadn’t dumped billions of dollars into mutual funds, none of the dazzling theatrics would have been possible. Without their blind faith in Greenspan, their suspended disbelief in a second- half recovery and their willingness to pay lofty prices for companies that don’t grow, the stock market averages would have ‘gotten the hook’ a long time ago.

– Investors tossed about $40 billion into mutual funds during the second quarter, according to Trim Tabs. "That’s a far cry from the $93 billion inflow registered during the first-quarter of 2000, when the stock averages peaked," notes CBS Marketwatch. Quite true, but $40 billion is also a far cry from zero, which is about the amount of investment dollars that a stock market selling for 30 times earnings deserves to receive.

– "California [is] on the brink of a fiscal disaster," gloats the Washington Post. "The nation’s most populous state, home to one of the world’s largest economies, has been staring in disbelief at the same dire predicament for months: a $38 billion deficit, the largest shortfall in its history and an extreme example of the budget woes afflicting many states…California’s $38 billion deficit is larger than the entire annual budget of any other state except New York. It represents about one-third of the state’s annual spending."

– The Golden State’s leaden finances are but one of the most visible after-effects of the busted stock market bubble. When the bubble burst, so too did the co-dependent technology-spending bubble and the capital-gains-tax- revenue bubble.

– $38 billion is a big number, even for the richest state in the Union. Heck, that’s the same amount of money that the entire nation of stock market investors added to mutual funds during the last three months. Where will California find this money? Will the Golden State "find" this money by raising taxes, or by firing state employees…or both?

– Whatever the solution, we doubt that plugging a $38 billion budget deficit will stimulate economic growth. Stock market investors might care – eventually – that throughout this fair land of ours, billions of dollars continue to pour down the rat-holes of budget deficits and pension shortfalls.

– It is curious, is it not, that the dollar has been rallying of late, even though the stock and bond markets have both been falling? Oftentimes, when stock and bond prices fall, the dollar also falls. But lately, the greenback has been bucking the trend. From whence cometh this curious dollar strength? Or it is really strength? Of course, the beleaguered currency had fallen so far so fast that it deserved a little respite from its travails. But maybe the respite is over.

– "It’s a selling opportunity," one anonymous hedge fund manager told me yesterday. Your New York editor could not conjure up a persuasive counter-argument. He, too, suspects that the dollar is better sold than bought at current levels. Perhaps it will continue to rally for a bit longer. But the reasons to steer clear of the greenback are as compelling as ever.

– "The dollar is hard to counterfeit and pleasing to look at," Jim Grant observes, "but it costs next to nothing to produce – much less, for example, than a bottle of champagne or a Toyota Celica. Not surprisingly, therefore, the United States consumes much more of the world’s goods than it produces – about $500 billion more…The dollar is welcome at fine stores and restaurants worldwide. In this sense it resembles the American Express Card. And it is like The Card in another sense: it is a monetary medium of no intrinsic value. Its circulation is faith-based."

– Will the dollar’s value hold up for another generation, Grant wonders? "We say no," Grant replies to his own question. We here at the Daily Reckoning would resond to Grant’s query as we often d "We don’t know if the dollar will succumb to the myriad pressures weighing on it…but it should." Our ignorance, as always, leads up to gold’s doorstep, where we beseech the ancient metal for a temporary safe-haven – just in case Ben Bernanke gets his wish, and helicopters do, in fact, begin dropping dollar bills from the skies.

– Turning to the ancient metal for help is only half the remedy, however; we must also know how best to win its favor. Steve Sjuggerud believes he’s found an answer – collectible gold coins. "Coins have been in a horrendous bear market for 14 years now. Today, 14 years after the peak, coin prices are STILL down an astounding 69%," marvels Steve. "Bargains abound in gold coins… The downside is almost non-existent. The upside is triple-digit gains."


Bill Bonner,
back in London:

*** While Moms and Pops get back into the stock market, the smart money continues to exit. Aren’t markets wonderful, dear reader? Such an elegant way of separating fools from their money! So beautifully undemocratic! In May, insiders sold $3.36 billion of stock, reports the Houston Chronicle. In the first half of June, they sold another $1.3 billion – – or about 10 times as much as they bought.

*** It must be a slow news day in England. The big story in the Times today is about Lady Archer’s facelift. Why it is important, we cannot say, but it is on the front page.

*** Harry Potter has taken France by storm, comments the Times. It is the first foreign-language book to become a bestseller in France. L’Humanité, the communist daily, complains that it is a product of "hypocrisy and odious commercial behavior…a typical example of the globalization of tastes and colors."

*** Over on page 13 is a story about internet tycoon Jay Walker’s suggestion to create a Home Guard of people who would spend their time watching bridges via internet and on-line cameras to protect them from terrorist attack! Good suggestion, Jay. Sign us up to watch the ornamental bridge in the Parc Monceau in Paris, and make sure you angle the camera to get the topless sunbathers on the grass – they looked dangerous.

*** "I actually supported the war against Iraq," said an American in London yesterday, after reading the English press for the last few weeks. "But it turned out to be nothing but lies. No weapons of mass destruction. No connection to terrorism. The Iraqis didn’t seem to be any danger to anybody but themselves."

And in yesterday’s Times, General Wesley Clark described turning Iraq into a showcase of democracy as a "grandiose dream."

*** Today is the anniversary of the Battle of the Somme, which began on July 1st, 1916. On this day, at dawn, 750,000 soldiers rose out of their trenches and encampments and began to march toward the enemy lines. It was the most catastrophic day in the history of the British Army. An unbelievable 400,000 soldiers died over the next few days.

For what? Monuments were erected to the fallen heros, but what was the point? Oh, if only the dead could speak! Woodrow Wilson spun it into a war "to make the world safe for democracy." Of course, he might just as well have gone over the side of the Germans and had the same grandiose dream. Both Germany and England had constitutional monarchs – who were cousins. Neither was a particularly shining example of democracy. Besides, why would anyone want a democracy? After WWI, Germany was pushed towards more democratic government – and elected Adolph Hitler!

American neo-conservatives claim to be inspired by the ancient Greek thinkers; they want to bring Wilsonian democracy to the entire world. But the ancients despised democracy. And yet, the neo-cons persist in pushing democracy on the world, like mobsters offering protection: take it or we’ll burn your house down.

The Daily Reckoning