Argentina is proof that there is no short cut to economic health
Argentina raised interest rates to 60% last week in an attempt to shore up the peso. It will prove to be futile. Once the numbers get that far off the chart, a country must concede that it’s not the right medicine for the disease.
The peso has already lost half of its value against the dollar in 2018, and the rout is probably not over yet. The latest slide was because of a plea for a faster than planned drawdown of the $50bn IMF bailout ($15bn has already been accessed, $35bn is still to follow).
Far from assuring the markets, the request has created even more panic. I would have thought that the outcome of that outcry would be obvious.
If the patient shouts out to the nurses’ station that he’d like more medicine before the next dose is scheduled, it is abundantly clear that he’s worse off, not better. Either that or the prescribed dosage was not right in the first place. I suspect that, in the case of Argentina and any such parallel situations, it’s a bit of both.
Interest rates at 60% have an astonishing effect on indebtedness. If countries borrow money at 60% for five years and are unable to service the interest, the amount owing at the end will be more than 10 times the original amount borrowed, whereas at 10% it would “only” be a little more than 1.5 times.
The real issue is not just the impact of compound interest. It is practically impossible to find any asset that can yield the kind of return required to service and repay the debt. This was the scourge of the microlending industry, which served only to provide an illusion of short-term remedy but ultimately further entrenched the poverty of desperate borrowers.
The crisis in Argentina is exacerbated by the even bigger inflationary challenges in Venezuela, not to mention Turkey. No emerging market will escape the contagion, and that includes SA.
The problem cannot be fixed with local interest rate policy or currency support. Those seek only to address the symptoms, not the causes.
If countries want to play in the big league, in the global economy, they must be competitive, at least at something.
Venezuela was gifted with huge oil reserves, but if countries mess with the management of a natural resource advantage, it won’t cover mistakes forever. Oil production in Venezuela has halved over the past five years, which has primarily been attributed to intervention of various government policies, such as expropriations and price-fixing, which have affected producer competitiveness in the private sector.
TELL-TALE SIGN
Confidence drives short-term market prices, but it is fundamental performance in the real economy that determines whether an economy will prosper or even survive in the long term. The first tell-tale sign of things not going in the right direction locally is a reluctance by foreign capital to invest through the local currency, forcing a country to fund capital projects (and current account deficits) in hard currency.
The ugly other side of that coin is that locals, in turn, start wanting to invest only in hard currency earnings. These compounding capital flows strangle the very same local industry initiatives that are required to succeed to escape the country’s economic woes.
The gut reaction to this developing problem is often even more intervention, even more populist policies and, finally, nationalism, which creates an artificial imbalance in the natural competition, a cornerstone of the optimal functioning of capitalism and the efficient allocation of scarce resources.
Money, real money that can pay for real things (such as imported food), cannot be “created” out of thin air. No amount of such money creation, or national support, can rescue dying fundamentals.
Eventually, it may be the medicine that kills countries, never mind the disease.
Only back to basics works. People have to get off the everstronger, ever-more-specific antibiotics at some point and start changing their lifestyle — exercise and eat properly. We all know that.
FIT FOR THE GAME
Whichever external forces one wishes to blame, it doesn’t matter. They remain external forces, out of one’s control. Business isn’t kind, particularly internationally, and empathy takes a back seat to opportunity.
Work out where you can compete and then invest in and get those industries fit for the game. The capital will come, at the right price.
As the old adage in the equity markets goes: get back to work, the share price will look after itself.
THE PROBLEM CANNOT BE FIXED WITH LOCAL INTEREST RATE POLICY OR CURRENCY SUPPORT