[A-List] vultures over Argentina

[Jorge Figueiredo <jfgf.consult@xxxxxxxxxxxxxxx>]

The Argentinean collapse - another IMF triumph

As predicted here, the Argentinean economic policy collapsed last week in
an orgy of anger in the streets where almost 20 percent of the population
is unemployed and the rest are threatened by financial ruin. They took
their anger out on the Finance Ministry, the erstwhile home of Domingo
Cavallo, the architect of the policy of pegging the currency to the US
dollar on a one-to-one ratio under what is known as a currency board. In
delicious, if futile, revenge they torched the dreaded ministry.
The elected President resigned to be replaced by a temporary fill-in of a
provincial governor whilst new elections are planned in the next 60 days.
In the meantime, there is no effective economic policy but the local
currency, the peso, is trading at about 1.5 to the USD on the streets and
the futures market expects it to be a two to one within a year.
Argentina's USD 150 billion of foreign debt is trading at between 25 and
30 cents on the dollar reflecting the reality that it is will inevitably
go into formal default within days.
Such a tragedy, so long in the making, has several fathers, although like
any illegitimate child they have all rushed for cover. The DNA tests will
however identify the IMF's as a prime suspect. With the enthusiastic
support of the US Treasury, they were the proponents of the concept of a
currency board to cure Argentina's endemic hyperinflation - which in the
1980s and early 1990s paralleled that of the 1930s Weimar Republic. It
was supposed to cure hyperinflation, eliminate all chance of devaluation
by maintaining at all times enough dollars in the central bank to cover
the Argentine pesos in circulation and, thereby, encourage investment in
the country and keep Argentine money in Argentine banks, rather than
those of Miami, Madrid and Milan.
Coupled with a policy of privatisation that brought in much needed
foreign investment from the US and Spain, the Argentineans engaged in an
orgy of borrowing, most of it denominated in US dollars. The problem was
that the country saved only 17 percent of GDP but invested (or consumed
23-25 percent). This compared with most Asian countries that save between
30 and 40 percent of GDP. But the geniuses who run large international
banks and international organisations did not seriously try and address
the imbalances for many years. They were delighted with the fees that
accrued from lending more and more.
In this respect, we recall a conversation with the President of one of
the largest US banks in 1995, claiming that Argentina would wipe the
floor with Asia (including China) in the long run. He was oblivious to
arguments about savings rates, education levels or work ethic. We
heartily disagreed and concluded that he was either completely
incompetent, had been seduced by a Latin lovely or had spent too long at
too high an altitude in his executive jet with the controlled substances
of the Pampas.  (It was probably a combination of all three.) He has
long gone, taken his multi-million dollar package at the shareholders
expense, and left his bank in a very exposed position. Good corporate
governance where art thou? That is for the other guy!
Now we face the nightmare that most middle class Argentines have their
home mortgages in dollars so if the peso is devalued they will be unable
to service their mortgages and lose their homes. This is a recipe for
further social unrest.
Given the severity of the situation, it is quite likely that a multiple
policy will eventually be introduced. This would include allowing the
peso to float (downwards) to a new level; renegotiating the foreign debt
after a period in default with a portion wiped out; and existing dollar
deposits and loans being converted to peso obligations at a new lower
exchange rate. Savers will have had some of their savings confiscated but
there will eventually be a chance of economic recovery after another
generation has needlessly suffered but at least the pain will have spread
around.

Investment implications

Who will gain? Politicians and others who held their funds abroad in
non-Argentine banks and the vulture investors, whether in defaulted bonds
or repossessed real properties. Indeed, opportunity is the flip-side of
risk. In this respect, we are attracted to the Telfonica de Argentine
Yankee bonds trading in New York, maturing in 2004, yielding 20 percent
to maturity and ultimately guaranteed by the Spanish phone company. The
risk/reward seems favourable. For other vultures, it could be a great
time in the next couple of years to buy an apartment or villa in Buenos
Aires.  The cost of living in dollar terms should plummet.

Contagion elsewhere

What should be watch out for? One is contagion to Brazil and other
emerging market economies. So far the omens are favourable but the
situation bears close watching. South Africa is suffering right now
although we believe the situation is different: at least, South Africa
has gold and other metals that people want to buy. Argentina only has
beef.
Asia, in general, is in relatively good shape to avoid fall-out from
Argentina. The concern for Asia will be the US economic recovery and
continued deterioration in Japan's economy that could affect their
currencies in the coming months.
The one remaining important currency board arrangement in the world is
Hong Kong. That arrangement is still as sound as a dollar - for the time
being. Hong Kong has massive currency reserves and no government debt.
Prices and wages have tended to be more flexible in a downward direction
than elsewhere. But the economy is sluggish and the important property
industry would like to see increasing property prices and an end to
negative equity in middle class properties. There are therefore
increasing sotto voce voices there for a more flexible exchange rate
policy. Eventually, the Hong Kong peg will likely undergo change but not
in the immediate future.

IMF policy

With the exit of Stanley Fischer from the IMF look for dropping of the
'two corner solution' to exchange rate policy of either pure floating -
as for the Euro, the Canadian dollar etc. - or a currency board as in
Argentina. The currency board arrangement is likely to be kept to the
refined form of 'dollarisation' and restricted to small economies such as
those in the Pacific Islands that cannot justify the expense of having
their own currency and therefore adopt another's currency. Micronesia and
the Marshall Islands use the US dollar and many other islands use the
Australian dollar.
It seems that the IMF and the US Treasury have decided to allow Argentina
to be the first major country to go broke rather than be bailed out with
more tax payer funds. Withdrawal of automatic future bailouts for the
profligate may, in fact, introduce greater caution into future lending to
emerging markets. Greater responsibility on the part of both investors
and borrowers is clearly to be welcomed, if scenes such as those in
Buenos Aires are to become less frequent in future.
William R. Thomson
Wt@xxxxxxxxxxxxxxxxxxxx
25 December 2001
Bill Thomson is Chairman of Momentum Asia, the Asian distributor of
Momentum (UK) fund of hedge funds. He is also Chairman of the Siam
Recovery Fund, a fund investing in Thailand and PEDCA inc a consulting
company. He is an expert on Asian economic and political affairs and is a
consultant to central banks and governments in the region on financial
sector reform.