Argentina Is Replaying Another Inflationary Collapse

Includes: ARGT
by: Nicholas Pardini

I knew the inflation situation was bad in Argentina (NYSEARCA:ARGT), but recent acts of desperation from the Argentine government have likely clinched an hyperinflationary collapse. Last week the government passed a two-month price freeze of groceries, and followed that up with an outright ban of advertisements that disclose consumer prices on Friday. These actions are signs of a desperate government trying to cover up its tenuous currency crisis to the general public. However, no real anti-inflationary measures -- such as reducing government spending -- will match these measures. Putting duct tape on the problem will do nothing to solve this.

Argentina has one of the worst track records in terms of both fiscal and monetary policy of all the emerging markets. Since 1950, the country has defaulted five times (1951, 1956 1982, 1989, and 2001) and has four separate years of hyperinflation (1981-82, 1989, and 2001). The actions of the Cristina Fernandez de Kirchner's administration are following a similar path with a familiar endgame. Throughout Argentina's history, left-leaning parties often promise social program spending to implicitly buy votes and win elections. When the bills for campaign promises come due, Argentina's tax revenues are not enough to pay for them. The consequences for this is unsustainable deficit spending.

Due to past defaults, Argentina has limited ability to issue local currency denominated bonds, and U.S. dollar denominated bonds come with high interest rates. As a result, Kirchner -- like her predecessors -- has resulted in printing money to finance expenditures. The Central Bank of Argentina has no independence whatsoever, so this policy is feasible. Inflation rates have risen slowly from her election in 2007 to 2011 when it breached 20%, according to private economists. The first step the government has taken to stem inflation has been to continuously lie about it. Official numbers for inflation are around 10.8% for 2013, while private economists estimate it to be closer to 30%. Manipulating inflation figures has reached a point where the IMF has censured the country for economic data fraud.

The next step has been capital controls. Argentina has outright banned U.S. dollar based transactions used for savings and has severe capital outflow restrictions to protect the currency. Argentina also has strict protectionist economic policies to artificially boost trade surpluses and limit imports that would drive down the peso's value. These measures have been disastrous for the Argentine economy, and only increase inflation fears among the local populace. Oil company YPF was nationalized as a further attempt to shore up government finances. Economic data distortion, capital controls, nationalization, and trade restrictions have done little to stave off currency weakness as the peso continues to decline and inflation rates accelerate even at a faster pace. Once these price controls expire over the next two months, expect food prices to rise at an even faster pace.

What should investors do when it comes to Argentina? If the ability to borrow is available through your broker, I strongly recommend shorting the peso against the U.S. dollar as the currency is likely to fall to zero. I would not recommend buying stocks or real estate in Argentina as higher inflation will evaporate the savings base of the country, which will reduce real consumption levels as well as restrict future local investment. Shorting stocks in Argentina is a good idea as long as it is in terms of a foreign currency, since hyperinflation will cause nominal stock inflation in terms of Argentine pesos. Real estate in Uruguay can also benefit from weakness in Argentina as wealthy Argentines historically have bought Uruguayan real estate as a store of value. Even if housing prices were weak across the Rio de la Plata, it would still hold more value than a peso denominated bank account.

History seems to be repeating itself once again as excessive government spending and a lack of credibility in foreign credit markets is leading to another episode of Argentinean hyperinflation. Investors should either be cautious about future investment in Argentina, or look for opportunities to short sell. The next time to be optimistic on Argentina will not be until there are signs that Kirchner's party will be out of power. However, with Kirchner seeking to change the constitution to allow her to run for a third term, this may not be for a while.

Disclosure: I am short ARGT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.