Originally published by Cuffelinks
In the early 20th century, Argentina was one of the world’s wealthiest nations, thanks to an educated workforce and agriculture. But after a litany of economic and financial crises, Latin America’s third largest country is not high on the list of places to invest for Australian investors.
Just three years ago it was being sued by investors, while simultaneously trying to avert its second debt default in a decade. Government ineptitude and volatile commodity prices have conspired to plunge millions of citizens into abject poverty.
A brief history of Argentina’s economic and financial crises is instructive, because while you may initially wonder what this has to do with you, the market’s current attitude to Argentina is vital in understanding where your returns are likely to go.
Impact of disappearing exports
In the 1930’s, Argentina was unable to escape the Great Depression as demand for its commodity exports vaporised. With government budgets plunged into deficit and public-sector workers unpaid, the military staged a coup in 1930 against the country’s democratically elected president.
Thanks to this precedent, and due to frequent economic disruption, more military leaders led the country than civilians throughout the 20th century, and between 1930 and 1983 presidents averaged only two years in office while the minister for economics was replaced annually.
After a brief period of post-war prosperity, in the early 1950s, commodity prices fell again. The nationalistic president Juan Domingo Peron took possession of British-owned railroads causing foreign investment to dry up. When inflation soared to 40%, real wages collapsed, and strikes following the death of Peron’s wife Eva Peron (you may recall the song ‘Don’t Cry for Me Argentina’) caused the country to grind to a halt. The military intervened again.
In the 1970’s the military regime was being begged by the constituency to return Peron from exile to the presidency and thanks to memories of the post war prosperity the generals relented. Peron died the following year.
Unsurprisingly, when the country made a former exotic dancer and Peron’s third wife his successor, several military and para-military factions struggled for control. In 1976, with inflation at 600% military generals staged another coup.
Many readers may recall the invasion of the Falkland Islands, a British colony, in 1982 with Argentina losing the brief war to the British. After the loss and human rights abuses during a war known as the ‘Dirty War’, the military was disgraced and democracy returned to Argentina, seemingly permanently, in the 1980’s.
Political and economic stability don’t go together
But political stability has not lead to economic stability. An expansion of government offices under president Raul Alfonsin, caused public sector wages to grow exponentially. Meanwhile, lax tax collection systems saw only one tenth of 1% of the population of 30 million Argentines paying income taxes. The consequential impact on the government’s budget and foreign investment saw inflation reach an unprecedented 5,000%. With rioters clearing out supermarkets, Alfonsin handed the presidency over to his elected successor, Carlos Menem, almost six months early.
According to many reports, Menem spent the 1990s attracting foreign investment, selling off loss-making state enterprises and cutting import tariffs. Inflation fell to single digits, and Argentina became the International Monetary Fund’s (IMF) poster child for free-market reform.
By the turn of the Millennium and Menem’s departure however, corruption was rife and Asia, Brazil and Russia’s financial crises saw foreign investment flee emerging markets like Argentina. Maintaining Menem’s Peso peg to the US dollar was impossible and, unable to print money, the government borrowed heavily.
In 2001 the country declared the largest sovereign debt default in history and a depression followed. In terms of income, over 50% of Argentines were ‘poor’, as were seven of every 10 Argentine children at the depth of the crisis in 2002.
In 2003, economic growth returned to an average rate of 9% for five years. GDP exceeded pre-crisis levels by 2005, and Argentina resumed repayments on defaulted bonds. By 2010, 93% of bonds were brought out of default through a second debt restructuring. According to most reports, bondholders who participated in the restructuring have been paid punctually and have seen the value of their bonds rise. In 2006 Argentina repaid its IMF loans in full. In 2016 Argentina came out of the default when the new government decided to repay the country’s debt, finally paying the full amount owed to litigious hedge funds.
Argentina is a country where economic instability is normal and locals will tell you another ‘crisis’ is underway or on the way. The country however has experienced its best run of growth since the post war boom thanks to high prices for commodities, due largely to demand from China.
Foreign investment returned in 2016, but the Peso has slipped to fresh record lows in recent months as government spending on social welfare programs, current account deficits and printing of new money has again fuelled one of the world’s highest inflation rates at 20% per annum.
Ok, so now you know something about Argentina going back nearly 90 years. What does it have to do with you? Well, just a few months ago Argentina joined Mexico, Ireland and the U.K. in issuing a 100-year bond. Only 12 months after it emerged from its most recent default the bond issued was massively oversubscribed, such is the desire for yield by global investors.
Another default in Argentina?
According to Reuters, Argentina received $9.75 billion in orders for the 100-year bonds and sold $2.75 billion at a final yield of 7.9% with a 7.125% cash coupon. That’s just 5% more than what investors are willing to lend at to the US government.
A reasonable question to ask is: do you think, inflation, higher interest rates or a default might happen in Argentina in the next 100 years? If the answer is yes, and that’s what the history lesson was for, then investors who hold this bond will have to endure capital losses at some point, while receiving a yield that is insufficient to compensate them for the risk.
When share market investors, including Australian investors paying high price to earnings (P/E) ratios of above 18 times, suggest high P/Es are appropriate given low interest rates, they are playing the same relative value game as the Argentinian bond investors. You can only accept paying a very high P/E if you also accept very low prospective returns.
The Argentinian bond issue, which coincides with Ivory Coast and Senegal offering 16-year bonds at 6.25%, Greek 5-year bonds at 4.63%, Iraq 5-year bonds at 6.75% and Ukraine 10-year bonds yielding 7.3%, suggests the market is at it again. It fears missing out more than it fears losing money.
Roger Montgomery is Chairman and Chief Investment Officer at Montgomery Investment Management.