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How a wealthy country declines into a rogue state

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One hundred years ago, Argentina’s meat and grain exports made it one of the world’s wealthiest countries.

It was richer than both Germany and France in terms of gross domestic product (GDP) per capita. And Argentines earned four times as much as Brazilians.

That’s why immigrants from all over Europe poured into Argentina in search of opportunities. Many took up residence in Buenos Aires – turning it into the “Paris of South America.”

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But as I’ll explain in a moment, over several generations, warped government policies and a particularly virulent strain of populism crippled the country’s economy and reputation.

And until recently, Argentina has had a particularly rough time since the dawn of the new century. In 2001, Argentina defaulted on US$95 billion in sovereign debt. Its currency lost half its value against the U.S. dollar from 2010 to 2014. And it saw one of the world’s highest inflation rates for a number of years.

Market commentators labelled the country as a “rogue state.”

The Economist wrote that, “when people consider the worst that could happen to their country, they think of totalitarianism… the real danger is inadvertently becoming the Argentina of the 21st century.”

I visited the country in 2014 – while it was in the midst of crisis. “This country is dead,” a professor at one of the country’s top universities told me.

Where things went wrong in the “Paris of South America”

One of the country’s early mistakes was not investing in its people. Over time, a weak education system hurt innovation and the quality of the work force.

Then, in July 1914, World War I began. Global trade, the mainstay of Argentina’s growth, was hurt. Its trade position was further eroded when Britain, a key trade partner, started trading more with the Commonwealth countries than Argentina.

But the real problems in Argentina began around 1946 – when Juan Perón was elected president.

Perón, who was the country’s president from 1946-1955 and 1973-1974, launched a semi-populist political movement called Peronism. The movement consisted of three ideals: social justice, economic independence and political sovereignty.

Juan Perón making a speech. Photo: informadorpublico

For example, one of the foundations of Peronism is government subsidies for children, health, transportation, education, utilities and energy. These measures help the poor. But they also distort economic incentives for individuals. And they’re almost impossible to get rid of… no politician can give money to constituents and expect to remain in office for long.

“Peronism has done more to hurt this country than anything else,” a local investor told me over steak in Buenos Aires a few years ago. “Perón helped create a mentality where short-term political advantage is more important than the health of the state… we’ve destroyed the country.”

The debt debacle

The destructive nature of the country’s populist approach is clear in its debt debacle. In 2001, the Argentine government ran out of cash and defaulted on US$95 billion of sovereign debt – the largest sovereign-debt default in history. In 2005 (and again in 2010), around 92 percent of the debt was restructured. Creditors agreed to a sharp reduction of the payment they were owed.

After the default, Argentina was closed off from international capital markets. No one would lend to a borrower who has a big, unresolved outstanding debt. The default also exacerbated a sharp economic contraction, faster inflation, higher poverty levels, the devaluing of the peso and large capital flight. Argentines no longer trusted the peso.

In 2002, there was a run on the banks when everyone tried to withdraw their savings at the same time – causing the government and banks to put restrictions on how much residents could withdraw to keep cash in the country. So in an effort to convert as much of their money as they could to a safer currency (the dollar), Argentines increasingly turned to the black-market money exchange.

The Kirchners were more bad news

Things got even worse under president Néstor Carlos Kirchner from 2003-2007… and then with his wife, Cristina Fernández de Kirchner, who was president from 2007-2015.

Under the Kirchners, the government’s role in the economy was increased to protect domestic industry and workers. Capital controls to prevent large sums of money from leaving the country were put into place… and legal contracts were disregarded. Meanwhile, the quality of life for regular Argentines deteriorated… and crime rose.

For example, in 2008, Cristina, as the locals call her, allowed the government to nationalise its citizens’ private pension funds to “protect retirees from falling stock and bond prices” during the global financial crisis. All the assets in individual accounts were transferred to the state’s mandatory system. Essentially, the government seized cash from its citizens to shore up its finances.

And in 2012, Cristina’s government expropriated Spanish energy company Repsol’s shares of a local energy company that it had bought.

Expropriation is the nuclear option in property rights. It’s when the state walks in and takes whatever it wants… regardless of the investor’s contracts or rights. There are few things more harmful to a country’s investment environment than expropriation.

Meanwhile, the International Monetary Fund (IMF) threatened to kick Argentina out of the organisation. The country had been falsifying inflation and economic growth data for years. (You could be sued in Argentina for publishing inflation and economic growth data that wasn’t in line with the government’s “estimates.”)

In short, Argentina saw one of the sharpest falls in economic freedom of any country over two decades.

Signs of decline

As a result of its terrible leadership and terrible policies, in 2014, the average Argentine earned just one-third of what people in Germany made.

In 2009, the country’s stock market was demoted from being an “emerging market” to a “frontier market.” Billions of dollars of investment capital flowed out of Argentina’s stock market.

Inflation in Argentina (measured according to private estimates, rather than doctored official data) was some of the world’s highest for years. Foreign investment in the country fell by 25 percent in 2013. Argentina’s foreign reserves (assets held by the central bank) fell by nearly half from January 2013 to July 2014.

And from 2010 to 2014, the country’s currency, the peso, lost half of its value relative to the dollar.

In short, Argentina was in a hole.

Turning things around..?

But recently, things have started to get better in Argentina.

In December 2015, Mauricio Macri, a former mayor of Buenos Aires, was elected president… and immediately launched economic reforms to revive growth and restore investor confidence in the country.

As a result of his work, in April, Standard & Poor’s raised Argentina’s long-term credit rating from “B-” to “B”, saying the country was on the verge of exiting recession. That still leaves Argentina’s credit rating in “junk” territory, but it is a vote of confidence in the policies of the new administration. S&P is the third big ratings agency to upgrade Argentina, following Moody’s last April and Fitch last June.

Argentina is also expected to see economic growth of 3 percent this year, up from a contraction of 2.3 percent in 2016. And inflation is forecast to fall by half in 2018, to around 16 percent.

The country’s stock market has also moved up from recent lows. The Buenos Aires Stock Exchange Merval Index is down 11 percent in U.S. dollar terms since Macri took office (it’s up 61 percent in Argentine peso terms – as the peso is down 47 percent against the U.S. dollar since December 2015 (that’s why the graph below shows such a sharp fall just after his election))… and up 12 percent in 2017 so far.

So things are finally looking positive for Argentina. But it’s not out of the woods yet. Policy, politicians and market sentiment are fragile – and can change quickly.

That’s why you need to do your due diligence before investing in Argentina – or any market, for that matter. Pay attention to the policies the country’s leadership is enacting… its economic freedom… and the faith investors have in its stock market. Understanding what’s going on in a country is essential to figuring out if it’s a great place to invest… or a financial black hole.

And that’s what I’ll be doing in a new service that we’ll be launching soon… so stay tuned for some very exciting news.

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