The Way of all Cash, Part II

Leave it to a world improver to run a once booming economy straight into the ground. Today, Bill Bonner concludes his two-part essay with a look at Perónism and the damage it did to the Argentine economy…

“All progress is based upon a universal innate desire on the part of every organism to live beyond its income.”

– Samuel Butler, Notebooks, 1912

In the late ‘80s and early ‘90s, the airlines were doing a brisk business shuttling economic advisors across the equator. We know; we were among them.

We once accompanied a group of investors and economists on a visit to the Casa Rosada in Argentina during this frenzied period of economic counseling. There, we found President Carlos Menem looking friendly but short. Argentina’s many financial crises seemed to have taken the inches off of him. He had done something even more remarkable than our own Paul Volcker. He had reduced the inflation rate from 200% per month to just 4% per year, by pegging the peso to the dollar at a one-to-one rate. But he seemed only half as tall as Volcker.

Our group was stone sober and barely interested in height; what we wanted to know was whether the gaucho would be able to maintain the peso equal to the dollar.

“Yes,” was the answer we got from the president of the pampas. “No,” was the fact of the matter. A few years later, the peso peg broke off like an airplane wing, and the Argentine currency suddenly crashed 60%.

That was not the end of our little chat. We got some advice and we gave some. The advice we got was that Argentina was safe for foreign investment; indeed, it was most welcome. The advice we gave was: “dollarize.” Our advice proved better than his.

Then as now, the United States of America was the world’s dominant financial power. And the coin of the realm was, then as now, not coin at all, but paper. Converting to dollars would take Argentine monetary policy out of its own hands. Judging from the evidence, past and future, it surely would have been a good idea. Rather than let the Bank of Argentina manage the nation’s money, it would be in the hands of Alan Greenspan.

Little did we know at the time, but Alan Greenspan had tango in his blood, too. Still, it was good advice. Argentina should have followed it. Instead, its own people juiced up the money supply at an average rate of 60% per year between 1991 and 1994. In 1996 and 1997, it went up at 15% and 20% respectively. It didn’t take long before prices were rising again and investors were beginning to call their banks in Miami. Even with very strong economic growth (Argentina grew at an 8% rate in the mid-‘90s, second only to China), the government still could not balance the budget. Public-sector debt soared.

By 1998, Argentina was in a slump; it needed to borrow more and more money to keep up with spending and make up for lost tax revenue. By late 2000, one out of every five bonds issued by an emerging-market country was Argentina. Investors began to wonder how the country could ever make good on so much debt. Speculators started dumping Argentine bonds and withdrawing capital from the country. Scarcely a year later, the whole jig was up. The currency peg was soon broken. The peso collapsed, and along with it, the Argentine economy. Unemployment soared. Banks were closed. Deposits were confiscated. And the Argentine middle class was practically wiped out.

But Argentine failures are not why we turn today to the world below the equator. We cross the wide River Plata not to offer advice, but to seek it, for we sense a financial crisis coming here in the North. Who knows more about how to survive it than the gauchos down south?

So, let us back up to a more benign period in Argentine history when the country was so blessed by nature that people lived as happily as Gott im Frankreich…until the 1930s. Before World War II, Argentina exported beef and farm products the way France now exports champagne and petit fours. During the war, the country was able to sell its produce to the combatants at a sizeable profit. By the war’s end, Argentina was a substantial net creditor to the rest of the world with an annual current account surplus of more than $6 billion (1950 dollars, which is to say, when the dollar was worth about 10 times as much as it is today). Left alone, the country probably would have gradually diversified its economy, improved its brands, sharpened its marketing and prospered at about the same rate as other European nations. As we will see, the spirit was willing, but the cash was weak. In less than 10 years, the surpluses were squandered and the nation was already suffering its first financial crisis of the post-war period. There would be many more.

Argentines have their own opinions about what went wrong. When the most recent crisis hit in 2001, they voiced them:

“People are dying because there is no food,” wrote one. “People are dying and are going to die because of lack of treatment for common illnesses: asthma, heart attacks, malnutrition, etc. We owe that to corruption.”

“You could buy anything from anywhere [before the crisis, now] not even Tylenol can be found on pharmacy shelves,” adds another eyewitness. “The price of typical cereal has tripled, and even people with offshore accounts can’t access them. Crime has increase exponentially as have the number of poor people begging in the streets.”

“The middle class, something we used to feel proud of, is now disappearing,” wrote another.

As you might expect, most people blamed the convenient bogeymen: greed, corruption, the United States and the IMF. But one brought the hammer down squarely on a homegrown culprit:

“All our problems effectively started as far back as 1930,” wrote Juan Casador, “with the ‘radical’ revolution. World War II was a respite and at the end we were very rich compared to Europe. Then came Perón who squandered it all. After that came the military who borrowed heavily. This is the basis of our current debt. All governments, since the military was thrown out by Maggie Thatcher, have been crooks. And stealing is a way of life. Any Argentine who does not steal is mad at those who do…until he gets a chance at it himself. We are a nation of liars, cheats, bullies and thieves. We deserve what we get.”

On whether or not Argentines deserve what they get, we have no opinion. But last week, we proposed a theory for what went wrong in Argentina not too different from Juan’s – Perónism. It was another Juan, Juan Perón, who brought National Socialism to Argentina in the war years. And at the close of WWII, when the other National Socialists were either hanging from hooks in Rome, or being incinerated in Berlin, Perón refused to die. Italy and Germany were reconstructed after the war, but in Argentina, Perónism lived on.

What is Perónism?

We’ll let the man who invented it answer. “Perónism,” said Perón himself, “is a new political doctrine.” We followed him up to that point. Then we were lost:

“[It] is a theory which establishes a little equality among men…and assures them of a future so that in this land there may be no one who lacks what he needs of a living…its aim is that every Argentine should pull his weight for the Argentines…Perónism is not learned, nor just talked about: one feels it or else disagrees. Perónism is a question of the heart rather than of the head. I feel an intimate satisfaction when I see a workman who is well dressed or taking his family to the theatre. I feel just as satisfied as I would feel if I were that workman myself. That is Perónism.”

Perónism was neither capitalistic nor communistic. Instead, it was advertised as a “third way.” What it really did was to take the worst elements from each. It was central planning, without plans. It was price fixing, without fixed prices. It was higher wages, with lower real earnings. It was crackpot economics, with the cracks…and minus the pots. It was huge new pork-barrel projects, without the pork. It was doggles without boons.

Perón’s government followed in Mussolini footsteps, encouraging higher levels of consumption, higher spending for government, more regulation, huge new doses of debt, nationalism, price controls, inflation, and special treatment for favored industries, particularly defense. This was a revolutionary new program for South America at the time, but a dead ringer for the Republic Party platform of 2004. Perón called it Justicialismo. It could as well be “Compassionate Conservativism.” It was even Perón who invented the notion of a “Homeland,” ranking it number one on his “scale of values.”

Once the Perónists were in control, the surpluses disappeared. Overspending and over-meddling produced their inevitable result. The economy began to wobble. What could Perón do? He was no economist, not even a quack one. But a skillful politician can just as well wreck an economy as build one up. Lies are what count; if he can tell whoppers well enough, he’ll be able to pin the blame on someone else. And gather even more power to fix it! Perón looked around. There they were, the rich, the traitors! The conservative old families, the stick in the muds! And the Catholic Church!

Perón’s world-improvement ambitions went beyond finance and economics. He planned to legalize prostitution and legalize divorce. When the church opposed him, he sent out his trade-union goons to sack every major church in Buenos Aires. And when the old money squawked, he burned down the Jockey Club.

By now, the idealist was really getting wound up:

“With our tolerance stretched, we have earned the right to punish them violently. From now on, the order for every Perónista, alone or in a group, is to respond to an act of violence with another act of violence. And whenever one of us falls, five of them will fall.”

Soon, he had gone too far. He was inciting his prole followers to mob violence – the very thing the military most feared. The army rose up against him. On September 16, 1955, the Cordoba garrison broke out in open revolt. Navy warships blockaded Buenos Aires and threatened to blow up the oil refineries on the Rio Plata. A cruiser began shelling the docks on September 18, 1955. General Pedro Aramburu declared himself against the regime in the Northeast. General Lonardi swept into Buenos Aries itself on the 23rd, greeted by cheering crowds.

Perón was finally gone, but when he left office he left, in the words of Argentine economist Raul Prebisch, a “crisis of unparalleled gravity.” Instead of investing in industries that might have created jobs and profits, people had shifted to speculating…and had taken their money offshore to protect against inflation and devaluations. On their own, the smart gauchos had learned how to dollarize themselves.

The economy slumped. Prices rose. Argentina experienced “stagflation” years before it hit the United States. The money supply exploded. Corruption became common. The middle class, too, tried to duck and dodge the Perónist economy. A large part of the economy went underground. Half of all eligible taxpayers didn’t bother to file a return.

The generals quickly tried to undo the damage, but the whole rotten system was beginning to stink. The workers demanded higher wages. Prices rose out of control. Debts increased. Taxes went unpaid. Perónism wouldn’t die. New crises came: devaluations, inflation, strikes, coups d’etat, defaults, revolutions. They continued for the next 35 years, right up until the early ‘90s. Each of these crises had Perón’s fingerprints all over it, for they were the products of the old “justicialismo”: too much spending, too much debt, too much currency, and too much meddling. Debts mounted up even higher. Banks tottered. Inflation rose to 600% and then to 2,000%. It finally settled around 4,000%. Budget deficits rose to 13% of GDP. External debts reached 44% of GDP.

Then, Carlos Menem, a member of the Perónist party, linked the peso to the dollar, on a one-to-one basis and began, again, to remove the Perón-era controls. Finally, with this new, more solid money, the economy breathed…it opened up…it prospered. Argentina was escaping the dead hands of Perón at last. Just to make sure, someone broke into Juan Perón’s crypt in La Chacarita Cemetery and cut his hands off!

Even that was not the end of it. While Menem reformed, the old habits continued. Debt. Spending. Inflation. Finally, the government caved in, and the peso collapsed. Once again, from 2001 to 2002, Argentina was in crisis.

But the Argentines are resilient. The economy has been recovering for the last three years. In 2003, the economy grew at a rate even India would be proud of: 8.4%. The cafes are filling up. Prices are rising. The country would probably prosper, if the Perónistas would just leave it alone.

Bill Bonner
The Daily Reckoning
June 2, 2006

Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).

In Bonner and Wiggin’s follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is – an empire built on delusions.

Yesterday, the price of gold dropped another $15. If it was a bargain on Wednesday, it was an even bigger bargain on Thursday. Now, it is Friday morning and we are wondering: What kind of a bargain will it be by day’s end?

If we knew, we would say so. We do not hold back, dear reader. But if we knew – well, never mind.

The question is this: Is this a bubble or is it a correction in a long-term bull market? We have already given you our answer; here is more in the way of explanation:

As we mentioned yesterday, the Japanese adopted ZIRP (Zero Interest Rate Policy) in the mid-‘90s. But the Bubble Era officially began 10 years earlier, at the Plaza Hotel, in New York City. Then, as now, the United States was pounding the table to get one of its chief trading partners to revalue its currency. American industries were losing market share. U.S. financial strategists wanted a cheaper dollar. But then, it was Japan not China, they were trying to bully. And then, it worked.

Japan buckled. It agreed to raise the yen. A higher yen would make it tougher for the Japanese to compete on price alone. Thereafter, they’d have to compete on quality. No one knew it at the time, but the pushy Americans had doomed their own auto-industry, by forcing Japan to produce better cars.

Nor did anyone realize what sort of effect this would have on the Japanese economy. The Japanese themselves feared the worst. They did what all central bankers are taught to do and then, being Japanese, they probably overdid it. While the yen was stiffened up on international currency markets, it was softened up at home to counteract the effect of a more expensive currency. The result was the “Japanese Miracle.” Property prices soared. The stock markets went wild.

But it was no miracle. It was a credit-spurred bubble, and not the first, nor the last.

It came to an end in January of 1990. At first, the Japanese did not know what to think. It was temporary, they thought. Just a correction, they said. Don’t worry, they told themselves. But when the slump didn’t go away, Japanese monetary officials overdid it again. This time they went “be-ZIRP.” We described their zero-interest-rate policy yesterday. The traders at Goldman Sachs and other hedge funds recognized the possibilities almost immediately. They were soon bidding up prices on everything from Russian bonds to American dot.coms. Forget about putting up factories or building companies; there seemed to be no end to the money that could be made in speculation.

Thus began a whole series of bubbles all over the world – Russian debt, Asian currencies, U.S. tech stocks, American household credit, housing in almost all the Anglo-Saxon countries, emerging stock markets, Bombay apartments, contemporary art, commodities…and now, maybe even gold.

When one blew up, it was on to the next one! Whee! Wall Street and the City never had it so good.

What’s more, it looked like it would last forever. While central banks lent money below the inflation rate, the forces of deflation held down consumer prices. Globalization and communication technology were forcing labor rates worldwide down toward the lowest common denominator. And Wal-Martization delivered products at bargain prices to consumers everywhere…buying in huge quantities from the lowest-cost provider and offering them in no-frills shopping Meccas with the lowest-possible mark-up.

And so, the Great Speculation Nation was born. Its beneficiaries did so well with it, one of them was just nominated as U.S. Treasury Secretary.

Over at Slate, Daniel Gross describes Goldman Sachs as a giant and an “extraordinarily profitable hedge fund lashed to a highly profitable investment bank.” He goes on to say, “As Goldman’s remarkable first-quarter earnings report shows, $6.88 billion of the firm’s $10.34 billion in total revenues came from trading and principal investments.

“In the 1990s, exposure to the retail sectors of the financial services industry – and to the conflicts of interest and scandals that ran through them – tarnished the images of many large Wall Street banks and their leaders, including Citigroup, Merrill Lynch, and Credit Suisse First Boston. Although Goldman Sachs was a party to the Wall Street research settlement, it emerged from the scandals in better shape than many of its rivals.”

Others would disagree. According to Peter Flaherty of the National Legal and Policy Center, Goldman has “an unusually tangled relationship with the Nature Conservancy, a group that is just coming off a string of scandals.”

Of course, Goldman has other advantages:

“Former Goldman heads have something else to recommend them to public service: They’re insanely wealthy,” notes Gross. “According to Goldman’s most recent proxy statement, Paulson has a 4.58 million-share stake in the company worth nearly $700 million.”

But the $64,000 question – or, to put it in terms Paulson can appreciate, the $64 million question – remains. Will Paulson make a difference?

“Will he do a better job than Snow of telling American workers, who have seen the median income fall, that they’ve never had it so good?”

He will barely try, is our guess. Liars and apologists are a dime a dozen in high places. Paulson has another, tougher role to play: He is expected to keep Speculation Nation in business.

More news from our team at The Rude Awakening …


Addison Wiggin reporting from Baltimore:

"The big number came in mid-April 2005 – $58.3 billion. It sat on the weekend news like a bum at a wedding. Where did he come from? No one wanted to ask questions; he might be a member of the other family!"


Bill Bonner with more views…

*** We wondered why falling house prices in Britain have not triggered serious economic trouble. In Britain, as in America, speculation on housing has become a popular folly; debt has become a major problem. The Brits are now on the hook for nearly $2 trillion in mortgage debt. People count on rising real estate prices in order to continue spending at the same rate. So, you’d expect at least a slump if prices went down.

But now, it’s been more than a year since housing prices were supposed to have begun falling and still the English economy is doing quite nicely, thank you. Yes, bankruptcies are running at record rates, but otherwise, the economy appears healthy (Or, let us put it this way: if you want to go to a good restaurant, make sure you call ahead for reservations). A conundrum? A puzzle? A curiosity?

Well, it turns out that house prices aren’t falling after all. And neither are the prices falling in the United States. Permits are down. Mortgage applications are falling. Inventories are hitting record levels. But according to CBS in the United States, “home prices rise but at a slower rate.” We read similar headlines about the English property market.

What does this mean? Only that the theory is still untested. We believe that lower property prices will produce a recession and a bear market on Wall Street. We can hardly wait to find out if we’re right.

[Ed. Note: Although home prices haven’t seen a major drop, the esteemed Dr. Richebächer believes real estate is "done" as an investment, for a long time to come. He’s not turning to bonds or mutual funds – or even the stock market to put his cash, either. But all is not lost…the Good Doctor has found the only five investments you should own over the next 12 months.

*** “Are you buying gold at this price?” asked a friend yesterday. “Do you think it will go lower?”

Again, we tried to explain ourselves. We buy gold when we have some money in our pocket and nothing better to do with it. Personally, we have made a number of family-related financial commitments. We’re not in a hurry to buy, merely because we have nothing much to buy with.

Beyond that, we can guess along with everyone else. Our guess is that this correction has further to go. Under $600 is our guess. Maybe under $550. But who knows? When it looks as though the correction is over, we will reach into our pockets to see if there is any money available to buy gold.

While we are on the subject of our own investing, we would like to confess that we do not even try to make a profit from our investing. We only try to preserve our capital. Why? Because we have been very lucky in business…lucky in love…lucky in family…lucky in so many ways. Expecting to be lucky in our investments would seem like ingratitude on our part.

*** We were in France yesterday. We saw no sign of riots, but the place had a gray, downcast look to it. The weather was so cold and miserable we felt sorry for tourists and street bums.

Every block or so, a beggar asked for money, including a beautiful gypsy girl on the Rue de Rivoli. Gypsies on the Rue de Rivoli are usually fat, ugly women holding dirty babies, at least those who hustle tourists. This Esmeralda, by contrast, turned our head.

“Do you speak English?” was her come-on line.

“Non,” we lied. For we are human, too – or at least Irish. We can resist anything, but temptation. So, we try to stay away from it.

Meanwhile, French Socialist candidate Segolene Royal is also a beauty. You see her photo on the cover of dozens of magazines in France. The French can’t seem to get enough of her. She is taking a page from the Hilary Clinton Guide to Politics. While her rivals are falling on their swords, she is picking hers up – moving to the right in order to appear more centrist. Yesterday, she proposed taking such tough action against hoodlums and troublemakers that even her own lefty supporters were shocked.

The Daily Reckoning