Inflation: A Story From Argentina on How Bad It Can Get

Commentary Last week, we gave a fair hearing to the arguments made by people who believe that the current high inflation rate is transitory and that we’ll be back to some version of “normal” by the end of the year.  This week, we’re going to explore what happens when conditions become worse than anyone expects. I’m writing this while traveling from Arequipa, Peru to Cusco, Peru.  For me, one of the best parts of traveling is the serendipitous interactions I have with fellow travelers.  Earlier this week, I was fortunate enough to have dinner with a doctor from Buenos Aires, Argentina.  Iván Paz is working in Arequipa right now, and when I asked him how long he planned on staying, he told me that he was never going to live in Buenos Aires or his native Argentina again. I visited Buenos Aires years ago, and like many, found it completely charming.  It has the beautiful architecture, cosmopolitan services, and fantastic restaurants found in many European capitals.  It also has the warmth and charm of a South American country.  Men I just met hugged me.  Women I just met kissed me.  It’s hard not to love a visit to Buenos Aires. Naturally, I asked my dining companion why he was so adamant about never returning.  What follows is his story.  I don’t understand Argentinian politics well enough to have an opinion about his views, but I can confirm that his economic analysis is sound. Iván told me that the government offered generous welfare payments to people who didn’t work and that instead of this being temporary assistance, there were many families that hadn’t worked in several generations.  He said that the government spending huge amounts of money they didn’t have led to an increase in the money supply and very high levels of inflation.  Readers of this column will recognize the connection between excessive government spending, high levels of currency creation, and the ensuing inflation.  He also mentioned that the government was taking in large numbers of people fleeing from Venezuela and mentioned the irony of using socialist policies to aid people fleeing from the socialism they had voted for themselves.  (Many forget that Hugo Chavez was popularly elected multiple times.) When he told me that the annual inflation rate in Argentina was 40 percent, I asked him how mortgages were structured when someone wanted to buy a house.  He laughed and replied that buying a house wasn’t possible.  When I pressed for more information, Iván told me that almost a decade ago he bought a house.  The bank financed 50 percent of the purchase price at a 14 percent rate; conditions that would cause domestic unrest here in the United States. A graph showing the declining value of the Argentinian Peso vs the U.S. Dollar since 2001. (Investing.com/Deep Knowledge Investing) As proof that government policy regarding money supply and excessive spending matters, we show what’s happened to the currency of nearby Peru.  Please note the relative stability of the Peruvian Sole versus the constantly plummeting value of the Argentinian Peso. A graph showing the declining value of the Argentinian Peso vs the U.S. Dollar since 2001. (Investing.com/Deep Knowledge Investing) Despite mortgage conditions that Americans might consider awful, I realized that getting 14 percent financing when the value of the currency used to pay the mortgage payment was depreciating at 40 percent was actually a great deal.  I asked my friend how the banks didn’t go out of business effectively lending at negative 26 percent, and he replied that the banks were fine because the government had guaranteed the bad loans.  Astute readers will remember that the U.S. government supplying guarantees for bad mortgage loans was a key element of the 2008 great financial crisis.  The story I was hearing was getting to be uncomfortably familiar. I asked Iván what happened to these loan programs, and he said that a year after he bought his house, the loan programs were all closed.  In fairness to the banks, there’s no reasonable way to make multi-decade loans when inflation is running at 40 percent.  Iván said that now, if someone in a highly-educated profession (like a doctor) wants to buy a home, it takes about three years to save enough for the down payment on the land.  That’s before buying a single brick, roof shingle, flooring, or plumbing supplies.  He’s correct that under these conditions, it’s not possible to buy a house. Recently we wrote an article explaining that if the U.S. Federal Reserve raises interest rates, it would make mortgages more expensive, and in turn, be likely to cause a fall in the value of homes.  So, the seller gets less, and the buyer has the same mortgage payment and expenses.  That’s not an ideal situation.  However, Iván’s story about Argentina illustrates a worse situation; when inflation and interest rates reach a level where hard assets, like a house, are only affordable for the wealthiest few. The U.S. Federal Reserve needs to re

Inflation: A Story From Argentina on How Bad It Can Get

Commentary

Last week, we gave a fair hearing to the arguments made by people who believe that the current high inflation rate is transitory and that we’ll be back to some version of “normal” by the end of the year.  This week, we’re going to explore what happens when conditions become worse than anyone expects.

I’m writing this while traveling from Arequipa, Peru to Cusco, Peru.  For me, one of the best parts of traveling is the serendipitous interactions I have with fellow travelers.  Earlier this week, I was fortunate enough to have dinner with a doctor from Buenos Aires, Argentina.  Iván Paz is working in Arequipa right now, and when I asked him how long he planned on staying, he told me that he was never going to live in Buenos Aires or his native Argentina again.

I visited Buenos Aires years ago, and like many, found it completely charming.  It has the beautiful architecture, cosmopolitan services, and fantastic restaurants found in many European capitals.  It also has the warmth and charm of a South American country.  Men I just met hugged me.  Women I just met kissed me.  It’s hard not to love a visit to Buenos Aires.

Naturally, I asked my dining companion why he was so adamant about never returning.  What follows is his story.  I don’t understand Argentinian politics well enough to have an opinion about his views, but I can confirm that his economic analysis is sound.

Iván told me that the government offered generous welfare payments to people who didn’t work and that instead of this being temporary assistance, there were many families that hadn’t worked in several generations.  He said that the government spending huge amounts of money they didn’t have led to an increase in the money supply and very high levels of inflation.  Readers of this column will recognize the connection between excessive government spending, high levels of currency creation, and the ensuing inflation.  He also mentioned that the government was taking in large numbers of people fleeing from Venezuela and mentioned the irony of using socialist policies to aid people fleeing from the socialism they had voted for themselves.  (Many forget that Hugo Chavez was popularly elected multiple times.)

When he told me that the annual inflation rate in Argentina was 40 percent, I asked him how mortgages were structured when someone wanted to buy a house.  He laughed and replied that buying a house wasn’t possible.  When I pressed for more information, Iván told me that almost a decade ago he bought a house.  The bank financed 50 percent of the purchase price at a 14 percent rate; conditions that would cause domestic unrest here in the United States.

Epoch Times Photo
A graph showing the declining value of the Argentinian Peso vs the U.S. Dollar since 2001. (Investing.com/Deep Knowledge Investing)

As proof that government policy regarding money supply and excessive spending matters, we show what’s happened to the currency of nearby Peru.  Please note the relative stability of the Peruvian Sole versus the constantly plummeting value of the Argentinian Peso.

Epoch Times Photo
A graph showing the declining value of the Argentinian Peso vs the U.S. Dollar since 2001. (Investing.com/Deep Knowledge Investing)

Despite mortgage conditions that Americans might consider awful, I realized that getting 14 percent financing when the value of the currency used to pay the mortgage payment was depreciating at 40 percent was actually a great deal.  I asked my friend how the banks didn’t go out of business effectively lending at negative 26 percent, and he replied that the banks were fine because the government had guaranteed the bad loans.  Astute readers will remember that the U.S. government supplying guarantees for bad mortgage loans was a key element of the 2008 great financial crisis.  The story I was hearing was getting to be uncomfortably familiar.

I asked Iván what happened to these loan programs, and he said that a year after he bought his house, the loan programs were all closed.  In fairness to the banks, there’s no reasonable way to make multi-decade loans when inflation is running at 40 percent.  Iván said that now, if someone in a highly-educated profession (like a doctor) wants to buy a home, it takes about three years to save enough for the down payment on the land.  That’s before buying a single brick, roof shingle, flooring, or plumbing supplies.  He’s correct that under these conditions, it’s not possible to buy a house.

Recently we wrote an article explaining that if the U.S. Federal Reserve raises interest rates, it would make mortgages more expensive, and in turn, be likely to cause a fall in the value of homes.  So, the seller gets less, and the buyer has the same mortgage payment and expenses.  That’s not an ideal situation.  However, Iván’s story about Argentina illustrates a worse situation; when inflation and interest rates reach a level where hard assets, like a house, are only affordable for the wealthiest few.

The U.S. Federal Reserve needs to respond to the current situation.  Inflation is at a 40-year high, real interest rates are at record negative levels, and as of this writing, they’re still engaging in Quantitative Easing (increasing the money supply).  Even the most hawkish (aggressive) members of the Fed think they’ll be able to get away with a 2 percent increase in interest rates.  We don’t think the United States is heading in the direction of Argentina right now, but there are many parallels between Iván’s story and U.S. economic policy.  Argentina represents a warning on how bad things can get if our institutions don’t take the current situation seriously.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.


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Gary Brode has spent three decades in the hedge fund business. Most recently, he was Managing Partner and Senior Portfolio manager for Silver Arrow Investment Management, a concentrated long-only hedge fund with options-based hedging. In 2020, he launched Deep Knowledge Investing, a research firm that works with portfolio managers, RIAs, family offices, and individuals to help them earn higher returns in the equity portion of their portfolios. Mr. Brode’s work has been featured in the Wall Street Journal and Barron’s, and in appearances on CNBC, Bloomberg West, and RealVision.