The Bear’s Lair: Redemption is not quite that easy

Argentina’s $15 billion bond issue, engineered by their new market-friendly president Mauricio Macri, was four times oversubscribed and increased to $16.5 billion. The Brazilian Congress has voted to impeach President Dilma Rousseff, suggesting that leftist policies may be on their way out there, too. These events give hope to those still suffering under extreme leftism, as in Venezuela and Cuba, or under more moderate forms thereof, as in the United States. Unfortunately, historical experience shows that effecting meaningful long-term change will not be that easy.

Take Argentina first. Macri is in for the next four years until December 2019, although he does not have a reliable majority in Congress. That means the 3-year tranche of Argentina’s new bond issue is probably pretty solid. However, the 5-year tranche looks pretty dubious and I would not touch the 10- or 30- year tranches with a ten-foot pole.

Argentina’s problem is that it has an ingrained history of bad policy and bad behavior in general, which has produced bad institutions and economic outcomes far worse than should have been expected given its human and natural resources. It is not entirely the Argentine people’s fault; being subject to the cycles in two groups of commodities, agriculture and minerals, it has been impossible for the electorate to connect the inputs of good or bad policy with the outputs of good or bad outcomes.

In 1929, having been well run since 1860, by and large, by a free-market oligarchy, Argentina was one of the world’s richest countries. Then in the 1930s it suffered badly because world trade collapsed and many countries, especially the British empire, imposed additional tariffs. The oligarchy remained in power, but maintained itself by rigging elections. The left that has dominated Argentine politics since that time dubbed the 1930s the “Infamous Decade,” and used this black legend to perpetuate their power (much as the left’s condemnation of the relatively prosperous 1930s was used in postwar Britain.)

Argentina then had a “good war” in World War II, piling up FX reserves, because demand for its products exceeded supply. However, a 1943 coup brought the radical populist Juan Peron to power. Within ten years he had run down Argentina’s huge reserves and bankrupted many of its business, wasting the country’s wealth on futile attempts to establish heavy industry and other boondoggles. The coup that ousted Peron in 1955 was probably a year or two early; the futility of his economic management had not yet become completely clear to the electorate as a whole.

In any case, Argentines were now convinced that populist economic policies brought prosperity, while free market ones bought distress. Every time the place had a free election, Peron himself or some other Peronist stooge was elected. Even when a military junta under Jorge Videla tried free market policies in the late 1970s, the junta was replaced and the economy run into the ground before the country returned to civilian rule in 1983. In the 1990s, after a massive burst of hyperinflation and default in 1990, a moderate, albeit still Peronist, Carlos Menem was elected, who tied the currency to the dollar, while borrowing abroad for the inevitable Peronist budget deficits, while the partially freed economy suffered from a decade of low commodity prices.

Then in 2001 the money ran out and Argentina defaulted, after which in 2003 the leftist Nestor Kitchner followed by his equally leftist wife Cristina Fernandez were elected. Needless to say, Murphy being apparently an Argentine leftist, commodity prices promptly shot up, making most of the Kirchner/Fernandez years prosperous ones, until with the decline in commodity prices since 2012 the money finally ran out.

Thus for a second time, the Argentine populace has been convinced that populist policies bring prosperity while free market ones bring only hardship. Add an education system that is only too willing to reinforce that message and institutions wrecked by decades of corruption which is very difficult to reverse, and you have an almost impossible task for Macri and any reformist successors. It is much more likely that reform will stall after a few years and the Argentine populace will elect another populist. That is what they have always done before.

In Brazil, the forecast is almost equally grim. Here the populists voted a new constitution in 1988 that enshrined public sector pensions and job security, making it impossible to rein back Brazil’s bloated public sector. In general, middle income countries, like Western societies of 1900, have smaller public sectors than the modern West, because the tax capacity of people near subsistence level is minimal, limiting the percentage of GDP the state can grab. Thus even though Brazil’s 41% of GDP devoted to the public sector is not excessive in Western terms – above the United States but below Sweden — it is far higher than most middle income states, which tend to take lower levels, such as the 29% in Colombia.

Both Dozy Dilma and her predecessor Luis Inacio Lula da Silva pushed up Brazil’s public spending, often hiding it through accounting tricks such as low-rate loans made by the state development bank BNDES to favored public sector projects. The problem is that even if Dilma is impeached, her Vice President was elected on the same ticket and there appears to be no prominent figure seeking to rein in the public sector, changing the constitution to do so, in the way Brazil needs.

As in Argentina Brazil needs better institutions, in this case a new constitution. It’s not at all clear that this change is achievable.

As for Venezuela, the ultra-left President Maduro is digging in against an opposition-controlled Congress. Here the position is even worse than in Argentina and Brazil; Venezuela’s oil reserves allow almost any kind of foolish policy to be funded. As in Argentina, the years of leftist Hugo Chavez coincided with high oil prices, so Chavez will always be remembered fondly, at least by poorer Venezuelans. The one advantage here is that no change is happening, while economic conditions continue to deteriorate. There thus appears to be no likelihood of a premature end to Maduro’s reign, as happened with Argentina’s Peron in 1955.

Thus if Maduro can in some way be removed, either democratically or otherwise, it seems possible that the Venezuelan people may have learned their lesson, and will allow a reformist government to operate. Still, Venezuela was notably badly governed even before Chavez, and has been steadily declining in productivity since at least 1970, so the likelihood of long-term reform is very limited.

This is not to say that Latin American countries cannot be well governed. Colombia, Peru and Chile, all with natural resources, have on the whole enjoyed decent government in the last decade, although Chileans must be looking forward to the end of Michelle Bachelet’s term of office in 2018. Still, there is a lesson here, which is that removing a truly bad government is fiendishly difficult, because voters’ belief systems, institutions and corruption combine to prevent you doing so without making a later relapse inevitable.

As for the Colossus of the North, it too has suffered from bad government, from both the last two Presidents, and is in serious need of reform. Here the problem is that Presidential candidates do not seem to understand the problem. Even the admirable Ted Cruz undertook a lengthy interview on economic policy recently, in which the interviewers pointed out several times that most wealthy countries were suffering low economic growth and productivity growth. In spite of these massive hints as to the true cause of the problem, Cruz failed to connect the U.S. and rich world productivity blight to the central banks’ ultra-easy monetary policy of the last decade, blaming instead over-regulation and taxation, the usual rightist suspects.

When by far the most intelligent of the U.S. presidential candidates fails to spot the real problem, there is little hope that the right solution will be chosen. This wasn’t a problem in 2012, when other candidates were forced to address Ron Paul’s accurate diagnosis of U.S. economic problems and their potential solutions, but Rand Paul’s early exit and the Trump distraction has prevented the issue from being addressed properly this time around.

Education and the media in the U.S. are firmly anti-reform, with regulation purely a party political issue, the budget deficit invisible and no significant voice for tighter money. Institutions used to be of very high quality, but the steady slide of the U.S. down the rankings of free markets and transparency shows clearly that they are not what they were.

When policies go wrong, returning to the right ones is not at all simple. It is therefore much easier to stay on the right track and avoid governments, even those allegedly of the right, that tug you off course. It’s a pity this lesson is so hard to learn.

(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.)