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Finance

Argentina defaults on debt: an economic crisis explained

Dateline: Kuala Lumpur, Malaysia

Not even thirteen years ago, Argentina defaulted on its debt for the second time in the modern age.

The result was what The Economist called “an economic crisis beyond compare”.

And the “corralito” – basically a financial playpen of sorts – was the long-lasting result that saw bank accounts frozen and the Argentine peso reduced to rubble after a decade being pegged to the US dollar.

In just one day, dozens were killed as riots consumed Buenos Aires and citizens shouted to throw the bums out. Most of the cabinet resigned and political turmoil was in full force.

By the time it was all over, fifty percent of Argentines were poor and the economy had cratered more than 20% in just a few years.

Of course, the already rampant inflation rates got far, far worse as the value of the Argentine peso, no longer able to rest on its US dollar peg, collapsed.

What caused this economic crisis? Three things, mainly…

First, runaway government spending. The government’s already nine-figure debt became unmanageable as Argentina’s government took on more and more foreign and domestic debt and saw their interest rates shoot through the ceiling. They got caught with their pants down.

Second, in an attempt to end their last bout of hyperinflation, some geniuses at the central bank pegged the peso to the US dollar. That was still the “strong dollar” era, and the government figured such a policy was a road to riches.

Of course, what happened is that Argentina’s neighbors merely benefitted from the newly strong peso and took a lot of business away from Argentina.

Lastly, a wave of privatization created conditions that were impossible for the average Argentine to manage. In addition to a new round of inflation from bad government monetary policy, some of the privatization involved crony capitalist deals where bureaucrats got paid off and looked the other way when utility prices suddenly went through the roof.

All in all, a recipe for disaster.

Today, disaster is back.

The government can’t pay back 2001 bondholders who held out for full payment, and now that a court in The Land of the Free has ordered them to do so (the bonds were issued through the US system), the country has gone back into default.

The financial media, with all of their love for bigger and bigger and governments, is eager to see the situation resolved. I saw one commentator today claiming that Argentina should get a private firm to buy off the hold-out bondholders so they can go back to… what else… racking up debt.

This time, he says, they can actually use the money to take some oil out of the ground or exploit other natural resources.

In a country that has been said to have revolution coursing through its veins, more government debt doesn’t sound like the best idea. The people of Argentina should know by now that the governments they have entrusted to protect their economy have almost all been a total sham.

Now that she is all but shut out of the world financial markets and declared a rogue state, Argentina’s psychopath president Cristina Fernández de Kirchner is trying to rehabilitate the country’s image.

However, “Argentina defaults on debt” is not exactly a new headline.

In fact, it’s been seen eight times before, starting in 1828, when Argentina defaulted on its very first bond, 44 years ahead of schedule. Current bondholders might take solace in the fact that that stand-off took 30 years to resolve.

While Argentina has one of the world’s most sophisticated populations, an endless supply of excellent land, and great natural resources, they can’t seem to get it together.

In fact, while Argentina was one of the world’s richest countries at the turn of the twentieth century, it has managed to mismanage everything (again) since then. It is proof that studying history will show just where the bodies are buried, and that there are plenty of nations that have come and gone.

Prosperity is not guaranteed nor never ending.

My steps to avoid being a victim of sovereign debt defaults

If you’re an international investor or freedom seeker looking to diversify your assets around the world, there are several simple, logical steps I recommend.

1. Avoid governments with high debt levels.
Living or investing in a country with out of control debt is like dating a guy who insults you on the first date. You figure it might be an outlier or that things can only get better, but it is just the beginning of a wild ride that will leave you battered and bruised.

High debt levels indicate fiscal irresponsibility. The United States government is Exhibit A for such irresponsibility, arrogantly believing that no matter how much they spend, they’ll still be rich.

Apparently no US politicians has ever heard of the Greek, Roman, British, or Ottoman Empires that rose and fell largely due to the same mismanagement.

While I am a fan of no government, there are plenty of countries running relatively tight ships. Singapore, for instance, has no net debt. Even socialist Norway has used their oil resources to actually create wealth, unlike The Land of the Free that has squandered it.

Agencies like S&P are now putting the hurt on Argentina as a result of its debt default, and that will cause even more problems for the Argentine people as costs rise. Even the US is not immune to this outcome, and I suspect you will see more riots and more mayhem in countries where the spigot of easy money gets turned off abruptly.

As they say, bankruptcy comes slowly, then all at once, and that is what you will see playing out on a street near you as government benefits get turned off and currencies become devalued if your government is a debtor nation.

2. Diversify out of the US dollar
Argentina figured hitching their cart to the US dollar wagon would solve all of their problems. It ended up causing them a lot of problems.

This is one reason I am more excited about Asia than Latin America. While Central America offers some of the world’s best residency opportunities for perpetual travelers, it is by its very nature tied to the US economy and US spending.

This trend is headed in the right direction, but dollarized economies like Panama concern me. Even here in Asia, people in Hong Kong are suffering inflation as a result of their Hong Kong dollar being tied to the greenback.

At least the Hong Kong dollar offers the potential of switching its peg to the renmibi, or being replaced by the renmibi altogether at some point.

3. Live and invest in economies based on culture
For years, Argentina has thumbed its nose at the world. It had no problem taking their money for their pet projects and to enrich the government, then balked at repaying their loans.

As a result, Argentina has become a basket case, complete with a healthy black market for foreign currency as the government has had to crack down on anyone with money. Argentines have been prohibited from owing foreign currencies or even taking money out of the country.

Capital controls became the norm.

You may enjoy living in a country that bullies the rest of the world… until the bully’s chickens come home to roost. Argentina is once again paying the price for having a government culture that played the victim rather than actually inviting people to do business there and respecting capital.

Argentina disrespected capital, and it got what it deserved.

The same goes for Puerto Rico. While many financial types, including our friend Peter Schiff, are cooing over the chance to pay low taxes in the US territory, I call a rat. Puerto Rico is an economic basket case with similar debt problems, and not a place I’d invest money.

I suspect you’ll see a bubble as New York fund managers head to Puerto Rico, snap up overpriced real estate in gated communities to protect themselves from the rest of the crime-ridden island, and drive up prices on everything.

If you can move to Puerto Rico, you can move to Panama. The United States is a mess and you need to distance yourself as much as possible if you want to avoid the splatter.

Argentina is proof that, no matter which bankrupt country you live in, the splatter is coming.

Licking around the edges and finding cute solutions to try and protect yourself isn’t going to work. Just ask the Argentines… or the Greeks… or the Russians… or the Serbians.

These people saw their entire nest egg vanish almost overnight because they believed their government would protect them and their money.

It didn’t.

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