One of the most remarkable economic reversals over the last decade has been the impressive macroeconomic discipline shown by leading emerging markets from Brazil to India, while developed nations such as the U.K. and U.S. have become increasingly reckless and profligate. While the former have been steadily re-rated by investors leading to a huge secular bull market in emerging market equities and bonds, the latter have yet to pay the price for their growing fiscal irresponsibility.
Argentina's troubled history in recent decades leads many to forget just how prosperous and advanced the country was a century ago. In fact, it was one of the ten richest countries in the world on a per capita basis until the 1930's. Any analysis of the country's stunning decline into inflation and dictatorship a few decades later must begin with the role of an entrenched economic elite who pursued their narrow interests regardless of the national cost. Rather than investment bankers, Argentina had a few thousand elite landowners who dominated the economy via agricultural exports. The pursuit of naked self-interest by these 'oligarchs' led to an increasingly unbalanced economy that underinvested in education and infrastructure and was dominated by inefficient monopolies protected by political patrons. That effort to protect the status quo at all costs via a captive political system led to the failure of attempts to modernize the economy and income inequalities growing to a destabilizing extreme.
Effectively Argentina metamorphosed from a productive to a rentier economy, with a small elite redistributing stagnant national income to their short-term advantage, with the rising frustration of the wider population eventually bought off with the printing presses. Sound even vaguely familiar?
America's strongest remaining economic advantage has been its ability to reallocate capital and talent to the 'new thing,' the innovative business models and technologies that can transform broader economic productivity and generate new wealth. That depends on both social mobility and an effective reallocation of capital and people from dying to rising industries; what Austrian economist Joseph Schumpeter termed 'creative destruction.' Regulatory and political capture by entrenched elites runs counter to both, and helps explain the unhealthy domination of the U.S. economy by the finance and healthcare industries over the past decade, whose political lobbying and funding dwarfs any other sector. An economy riven by narrow vested interests seeking to direct public policy and profit from public funds becomes one saddled with perverse economic incentives that undermine the purging and renewal process that is central to capitalism.
The end result is secular decline; imperceptible at first, but eventually leading to a crisis of confidence in a nation's currency and its debt obligations. The Soviet Union began an irretrievable decline from the late 1960's, caused by slumping productivity as real energy costs soared but also political capture by the military-industrial elite, as Kremlin factions competing recklessly to divert resources to their political constituencies. At one stage in the 1970s, the USSR was simultaneously producing five different battle tanks from four different decades, simply because military lobbyists in Moscow could work the system to obtain funding. Every Soviet leader from Khrushchev to Gorbachev attempted to control runaway military spending, but they were too weak to overcome entrenched interests until the whole shoddy edifice collapsed.
Where Argentina became dominated by absentee estate owners, and the USSR by military bureaucrats, America has allowed a massively disproportionate financial sector to dominate public policy, which despite its role in precipitating a systemic meltdown remains untamed. Competitiveness is in secular decline, as evidenced by the structural nature of the trade deficit. Even in the recent economic slump, it remained stubbornly high at $25 billion a month, and will likely revert to $40 billion-plus per month (or nearly 4% of GDP) in a muted recovery.
The U.S. hasn't generated a trade surplus since the early 1990's recession, all the while since accumulating a mountain of foreign obligations. Now, the necessary deleveraging of the U.S. consumer and financial sector has been postponed by massive government intervention. Total debt for the U.S. financial sector was $16.5 trillion in the second quarter 2009, almost identical to the level reported a year earlier. The apparent reduction in financial sector leverage (which reached over 30x for several investment banks) is due to a bigger capital base from equity issuance and a transfer of off-balance sheet liabilities into the public sector.
The huge shadow banking system, comprising hedge funds and non-financial entities from GM to GE, remains intact if somewhat chastened. Despite the asset reflation of recent months that has relieved the pressure on bank balance sheets and avoided the need to recognize huge residual losses (of over $1 trillion globally), regulatory reform has descended into the sad spectacle of posturing over bonus controls, missing the point that it is the obscene profitability of the financial sector (a tax on the wider economy) that drives that huge remuneration relative to other sectors. Until banks become subservient to the wider economy and regulated as the essential utilities they are, the U.S. will continue to suffer a chronic misallocation of capital and talent and relentless economic decline.
Argentina never had the advantage of a global reserve currency, and that certainly postpones the inevitable adjustment, but only for so long.
Disclosure: Long U.S. Dollar