The Bear’s Lair: Climbing out of the economic mire

Mauricio Macri’s surprise victory in Argentina last week has brought wild optimism to the Argentine markets, with the Merval index of Argentine stocks up 55% since late September. Yet Argentina’s sorry track record since 1943 and Macri’s lack of a Congressional majority suggest his chances of a long-term turnaround in Argentine economic fortunes are somewhere between slim and none. The reality is that, once policy becomes bad enough, reversing is almost impossible in a democratic system with regular elections.

Macri’s position is very similar to that of previous Argentine leaders elected after a burst of populism, notably Arturo Frondizi in 1958 and Carlos Menem in 1989 (some military leaders, notably Jorge Videla in 1976, also succeeded periods of populism.) None of these leaders succeeded. Menem came closest, leaving office in 1999 before the 2001-02 storm broke (he had fixed the peso to the dollar, but overspent the budget, attempting to cover the deficit by foreign borrowing.) Videla, whose finance minister Jose Alfredo Martinez de Hoz was by far the pick of the bunch, made austerity so unpopular that was succeeded by an economic populist even though both were technically unelected military leaders. Argentina has thus sunk from a relatively rich country in 1929 to an impoverished wreck today, and it’s very much the fault of its own people and their poor economic choices.

You cannot however blame Argentina’s failure entirely on the doziness of the Argentine electorate. Trends in commodity prices have played a substantial role in obscuring for the Argentine people the effects of economic policy, good and bad. Before the 1930s, Argentine economic policy was very sound, with only a modest populist hiccup in 1916-22, following the one man one vote Lei Roque Saenz Pena of 1912. However the world slump of the 1930s forced Argentine conservatives to fiddle the electoral system to stay in power, whereupon a decade of low commodity prices and restricted trade produced what populist Argentines know as the “Infamous decade” of considerable impoverishment from the high living standards of 1929. Then the postwar decade saw populist policies combined with high living standards, as Argentina spent the international reserves it had accumulated during the war years.

The late 1970s, when Videla and Martinez de Hoz tried to break the pattern, were a period of low commodity prices following the 1973 crash, as were the 1990s, when Menem pursued more or less sensible free-market policies, privatizing the energy company YPF, for example. Then after the crash of 2001-02, which was blamed on the free-market policies of the Menem years, the Kirchners (Nestor in 2003-07, his wife Cristina Fernandez de Kirchner in 2007-15) gained power and gave Argentina a decade of rising living standards, as high commodity prices allowed them to pursue economic policies that were more or less cuckoo, including an effective default on their foreign debt. Most important, living standards have only begun their decline in 2015, as commodity prices have declined and Kirchneromics ran out of money.

Since commodity prices are now fairly low and unlikely to rise (other than through a general surge in global inflation, which is certainly possible) it’s fairly clear what the four years of Macri’s term of office will look like. Macri will unify the peso exchange rate, alleviating the current shortage of foreign exchange but kindling inflation. He will produce honest economic statistics, demonstrating the damage done by the Kirchners but allowing the faults of his own government to become apparent. He will cut public spending and taxes, but will need to inflict pain if he is going to balance the budget. Finally, he will do a deal with the holdout Elliott Management group of creditors, providing the left with a populist issue and reopening international capital markets just as conditions there deteriorate in an environment of rising dollar interest rates.

Macri is however unlikely to improve the Argentine economy in any fundamental long-term way. He will lack a majority in Congress, so will be unable to pass legislation that, for example, might privatize YPF again. He will preside over only a modest surge of long-term foreign investment, as mining and energy projects, for which the up-front investment is large, will see saber-rattling by the leftist opposition as evidence that Argentina remains politically unstable. He may well suffer further problems if the world economy enters recession. Thus at the next election in 2019 he will preside over an economic record that has inflicted enormous if necessary pain on much of the electorate and is at best only beginning to show genuine recovery. At that point Cristina Fernandez, if she has not been convicted for one of the many crimes and peculations of her regime, will pounce and return the country to economic idiocy and decline.

Argentina is not alone. Consider for example the prospects for Russia in March 2018, when Vladimir Putin is due to run for re-election. The Russian economy is in decline, and does not seem to have bottomed yet; the IMF projects continued decline in 2016 and very modest growth in 2017. The Russian budget is heavily in deficit in 2015 and likely to swing into heavier deficit in 2016, with the delayed effect of the decline in oil prices. Russian military spending is increasing rapidly, and must continue to do so if Putin’s geopolitical ambitions are to be met with adequate military capability. At the same time, a new U.S. President will arrive in January 2017; the chances are surely high that he will be less supine against Russian expansionism than the present incumbent. Consequently it is likely that Putin’s re-election campaign will be a difficult one, and possible that as in Argentina the outcome will be an opposition victory (though one must doubt whether Putin will allow any such eventuality to occur.)

Consider however the inheritance of an opposition leader, perhaps a sober version of the well-meaning Boris Yeltsin, taking power in Russia in March 2018. Oil prices might well still be low, so there would be no chance of massive foreign exchange revenues. The commanding heights of industry would be in the hands of Putin’s cronies, so he would have no chance either to influence their policies or to install better or friendlier management without yet again violating property rights, a very fragile flower indeed in Russian circumstances. He would inherit a mass of military operations that would be expensive, unproductive of any gains that could be sold to the Russian people and that would bedevil his relations with the rich West. He would have very little chance of attracting foreign investment to boost the economy; the energy sector would be running down because of past poor management and low prices, while the remainder of the economy would be a “no-go” area for foreign investors because of the uncertainty of Russian property rights.

In short, like Macri, he would be very unlikely to achieve much change during his term in office, although admittedly in this case he would have six years rather than four before Putin swept vengefully back into office in March 2024 and undid all his good work. As in Argentina, Russian voters have been confused by high energy prices during a period of poor economic management. Thus the limited understanding of market mechanisms available in an economy that hasn’t been properly run since Piotr Stolypin was shot in 1911 has been further blurred.

The United States in 2017 may suffer from a similar problem. Here it is ultra-low interest rates rather than high commodity or energy prices that have allowed a poor economic team, both fiscal and monetary, to run unsound policies without the electorate realizing their dangers. It is of course possible that recession will hit before November 2016. But if it does not, the new President will be faced with a need for higher interest rates, massive public spending cuts and probably tax rises, just to restore the elements of sound policy.

He will also be faced with a global recession, early in his term, as the worldwide malinvestment caused by the appalling fiscal and monetary policies of the last seven years crashes dismally to the ground. While he will be able to do a lot to restore the economy by massive deregulation, if he does it quickly enough, it may well be the case that by November 2020 the memory of economic pain, tax increases, higher interest rates and the withdrawal of state freebies (almost certainly in healthcare, for example) will result in the election of a vengeful successor of Barack Obama and Hillary Clinton in the election of 2020.

In which case, the United States will probably descend into an Argentine hell, in which the economy steadily deteriorates, while the policies to turn it around are never properly applied. By 2070, the U.S. economy of 1999 may be looked back upon like the Argentine economy of 1929, as a lost nirvana to be succeeded by a series of “infamous decades” in which poor policy and bad luck combine to drive the country backwards into bankruptcy, hyperinflation and poverty.

There is one counterexample. When Britain’s David Cameron won the 2010 election without a majority, and formed a coalition with the Liberal Democrats, he promised five years of austerity, as the last years of Labour under Gordon Brown had combined with the 2008 financial crisis to drive the country close to bankruptcy. The next five years were difficult ones, with a renewed recession and no rise in living standards for the British people. Yet in June 2015, much to commentators’ surprise, Cameron won re-election with a full majority, and now has five years to produce some real results to demonstrate that improved policies can actually produce improved results.

In Britain and the United States, there is at least a memory of decent economic policies in the 1980s producing genuine economic improvement. That may be the difference, and explain why the British recovery from economic chaos was possible (albeit as yet incomplete) and why an American descent into Argentine hell may not be inevitable. But the danger is always there; if a rightist government produces poor policies and poor results, as did those of the two Bushes, or a leftist government is allowed to linger for more than a decade, as Labour was in the Blair/Brown years, then the electorate may become confused as to what works.

After all, if our leaders fail to grasp the principles of sound economics, we cannot safely rely on the superior wisdom of an electorate confused by extraneous factors and the witterings of economists, both alive and defunct.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)