A Recipe For Massive Hyperinflation or Bankruptcy
Martin Hutchinson: Nobody was really shocked when Venezuela devalued the bolivar earlier this month from 4.3 to the dollar to 6.3.
When it comes to the currency wars, massive devaluations are simply one of the keys to this “race to the bottom” strategy.
But Venezuela’s bad behavior, and that of several other countries in the region, means that several Latin American countries are now likely to suffer hyper-inflation or declare bankruptcy.
For investors in Latin America, that raises the risks for everyone, even for countries with good policies and relatively low debt.
Unfortunately, long-standing investors in this part of the world have seen this hyperinflationary pattern before.
Hyperinflation Gone Wild
For instance, Argentina suffered average annual consumer price inflation of 546% between 1975 and 1991. During that period it went through three currency re-denominations that included a 10,000-for-1 devaluation in 1983, a 1,000-for-1 in 1985 and another 10,000-for-1 change in 1992.
Similarly, Brazil suffered average inflation of 773% between 1981 and 1995. During that period it went through four currency re-denominations, with multiples of 1,000 for 1 in 1986, 1989 and 1993, and 2,750 for 1 in 1995.
Finally, Peru suffered average inflation of 809% between 1978 and 1993; during that period it went through two currency re-denominations, with multiples of 1,000 for 1 in 1985 and 1,000,000 for 1 in 1991.
In other words, in a period of less than 20 years, the three countries knocked 9, 11 and more than 12 zeros off the value of their currencies.
You’d think hyperinflation would prevent debt defaults, but in these cases it didn’t.
Argentina defaulted in 1982 and 1989, in addition to its other defaults in 1827, 1890, 1951, 1956 and 2002. Brazil defaulted three times during its period of hyperinflation – and another 7 times outside it.
Peru also defaulted three times during its period of hyperinflation – and six more times outside it. You wouldn’t want to buy the debt of any of these three losers, in my view, although Peru is currently notably better run than the other two.
As for Venezuela, it has managed so far to avoid the hyperinflation that has afflicted the other countries, in the sense that its annual inflation rate has never made it into three digits. However, its record on default is correspondingly worse, having defaulted no fewer than 11 times in its 202 years of existence as an independent nation.
What Latin American Investors Need to Know Now
Foreign investors in these sorry track records have lost their shirts, over and over again.
In the 1990s and 2000s, it seemed that the Latin American countries had grown up, with Argentina being carefully run and very popular in the 1990s, and Brazil having a very good run since 2002.
In some cases, the perception has continued:
- Chile has been well run economically by both autocratic and democratic governments since President Augusto Pinochet took over in 1973. It now has very little foreign debt and a reputation for integrity better than that of the United States, according to global surveys.
- Colombia, which had always been better at avoiding debt defaults (none since 1935) and has also avoided hyperinflation, currently appears one of the world’s best growth stories.
- Peru, which had a dreadful track record in 1978-93, has been much better managed since then, with relatively low debt. Even in 2010, in the early stages of the current enthusiastic market for emerging-market bonds, it managed to issue 40-year bonds.
Nevertheless, overall there are as many likely losers as winners.
Venezuelan inflation is clearly headed towards the triple digit level (49% annually in the last two months) and even if Hugo Chavez goes, his Vice President, Nicolas Maduro, is committed to the same overspending and hostility to international capital.
Argentina’s Cristina Kirchner jails people who disclose the true inflation rate (somewhere north of 30%) and is likely to run out of money soon – if she doesn’t start a war with Britain over the Falkland Islands first.
Brazil under Dilma Rousseff has gone ex-growth and is about to ramp up public spending again to pay for the 2014 World Cup and 2016 Olympics. In addition, smaller countries such as Bolivia, Nicaragua, and Ecuador are enthusiastically following in Chavez’ and Kirchner’s footsteps.
The point is if half the South American continent goes bust, it can’t be good news for the other half.
For one thing, trade relationships will be disrupted and companies with large operations in the bankrupt countries will suffer large losses.
For another, international capital markets are likely to “redline” the continent altogether as they did in the 1980s, even though at that time a number of Latin American countries were competently run.
Then there are the political repercussions if countries suffering hyperinflation or bankruptcy try to distract their citizens by starting a war. Old rivalries die hard, and Argentina/Chile, Bolivia/Chile and Venezuela/Colombia are all borders that have seen flare-ups in recent years.
It’s a great shame for the well-run countries of Latin America, which are doing things right, growing their economies rapidly, and deserve to be rewarded.
But as investors, we should be careful with our money. The currency wars make Latin America a very slippery slope.
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Martin is a Contributing Editor to both the Money Map Report and Money Morning. An investment banker with more than 25 years’ experience, Hutchinson has worked on both Wall Street and Fleet Street and is a leading expert on the international financial markets. At Creditanstalt-Bankverein, Hutchinson was a Senior Vice President in charge of the institution’s derivative operations, one of the most challenging units to run. He also served as a director of Gestion Integral de Negocios, a Spanish private-equity firm, and as an advisor to the Korean conglomerate, Sunkyong Corp. In February 2000, as part of the Financial Services Volunteer Corps, Hutchinson became an advisor to the Republic of Macedonia, working directly with Minister of Finance Nikola Gruevski (now that country’s Prime Minister). The nation had been staggered by the breakup of Yugoslavia – in which 800,000 Macedonians lost their life savings – and then the Kosovo War. Under Hutchinson’s guidance, the country issued 12-year bonds, and created a market for the bonds to trade. The bottom line: Macedonians were able to sell their bonds for cash, and many recouped more than three-quarters of what they’d lost – to the tune of about $1 billion. Hutchinson earned his undergraduate degree in mathematics from Cambridge University, and an MBA from Harvard University. He lives near Washington, D.C.