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What Lessons Can We Learn from Argentina's Debacle of 1998-2001?

February 18, 2009

It is not often that we Americans have the opportunity to examine the financial experiences of less developed countries and attempt to learn from them. Usually they learn-or should learn-from us, but now may be the time to humble ourselves and see if we might benefit from their experiences.

There are a great many parallels between Argentina's recent economic depression and the current situation we are facing in the United States. Argentina overcame its depression starting in 2002 but it left enormous financial wounds and dramatic losses. However, some investors had foresight and took certain actions which led them to make money-and lots of it-- while others saw their savings and investments dwindle. I believe we can learn from their examples, the good and the bad ones, and apply the lessons from Argentina so that we can place ourselves among the winners, when we get out of the current mess we are in.

The Drama: Argentina suffered an economic depression from 1998 through 2001. Unemployment shot up to 25%. Ours is rapidly climbing, as well. Argentina's quality of assets-real estate and equities-dropped dramatically. Do I have to remind you that our real estate prices have fallen between 20% and 35%? Similarly, our stock prices are down about 45% and may continue dropping. How did Argentine banks react to the drop in the quality of the assets? They experienced a seizure, literally. As a consequence of the drop in the value of the assets backing their loans, banks were unable to guarantee depositor's money. People started worrying and began to withdraw their funds. To avoid this capital flight, the governments froze most bank accounts over $500. In exchange, depositors were given a ten year government bond that immediately lost 30% of its value. What about our banking situation? Banks are going bankrupt right and left and, although deposits are FDIC insured, it won't be long before the FDIC may run out of money. Then what? You can draw your own conclusions.

That's what happened in Argentina and we seem to be following their lead.

What caused the Argentine debacle? In my opinion, the most important factor was an overvalued peso. As a result, more money was leaving the country than coming in. For example, exports were few, and imports were many because it was cheaper to buy from abroad than to produce domestically. As a result of the diminished economic activity, the Argentine government tax revenues fell and it started spending more than it was collecting, so it was suffering from a large deficit. Do you see the parallels here? The dollar is overvalued and the evidence is startling; our imports are huge, our exports are few. Our federal and state governments are in deficit spending-in trillions of dollars. Fellow Americans, we are living beyond our means, just like the Argentine people, prior to and during their depression.

How did Argentina overcome their depression? There were two major reasons; first, the government let the peso "float" or find its own value, and the market devalued it by about 70% within a few weeks. This led to a boom in exports and to a halt in imports because they became very expensive to argentines. In turn, this led to a rebirth of local manufacturing-it was finally cheaper to produce domestically than to import-which caused employment to start rising rapidly. This led to economic growth, and tax revenues skyrocketed. The government, all of a sudden, balanced their books; in fact, they started running a surplus. People were happier because they were working, and the end result was a booming consumer sector and economy.

The second major factor which helped Argentina surmount its depression was not a war but rather an astronomical rise of commodity prices in the international markets. This led to a further export boom, rising employment, and increased tax revenues. As a result of these two unrelated events, real estate and stock prices rose. Everyone was working and they were wealthier.

What Can We Learn from Argentina's Debacle? The surest way, aside from war, to get an economy moving and consumer demand to expand is to devalue the local currency. I believe that the dollar is overvalued-our trade deficit is an excellent manifestation of this-and so devaluing the dollar vs. other currencies will result in an economic boom. When the positive impact of President Obama's economic stimulus wears off, devaluation will look like a wonderful political recipe. But it will also cause many to lose big time. Who? Those who own dollar based cash equivalents and fixed income vehicles. The winners will be those who sold dollars before the devaluation and put it in safer currencies.

Investment strategy: To protect yourself against a likely future devaluation of the dollar, it is prudent to diversify your dollar holding now, before it is too late. You should consider putting money in a diversified basket of currencies like the yen, the euro, and the yuan (Chinese currency). You might want to consider other assets too, like gold and commodities.

What about equities? After the devaluation, we should experience a boom in equity prices because foreigners will begin a buying binge. Why? Because buying US stocks, for them, will be cheap. So, just like purchase of Anheuser Busch by the Belgians last year, you can expect a frenzy of foreigners buying some of the best American companies. So, scary as it is now, don't sell all your equities. Better times will come, and you don't want to miss that boat.

What about real estate? You can expect prices to increase rapidly, after the devaluation of the dollar.

In sum, Argentina taught me that to benefit from devaluation, you had better have your assets out of the country before the devaluation occurs. Argentine investors who put their money in dollars and Euros ahead of the devaluation were big winners. Those who bought stocks and real estate immediately after the devaluation were big winners. Finally, those who had fixed rate debts in pesos, before the devaluation, were big winners because their debts, in dollar terms, were liquefied after the devaluation.

If you need help with your financial planning or investing, even if it's just a critique of your current portfolio, please call me at (714) 771-6000 or send me an email to [email protected]. If you prefer, you can visit my website at I will be happy to set up a free consultation for you.

The Incas thought gold represented the glory of their sun god and referred to the precious metal as “Tears of the Sun.”
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