Investments at the Edge of the World

Part 1: Geography and history

The world is vast, and Alpha is everywhere. With this slogan, I am embarking on a journey through remote places. In a series of publications, I will introduce you to regions that offer unexpected investment opportunities.

We will travel through continents and countries outside the majority’s focus. When they come into the sight of market participants, the fruits will already be picked. The first stop is South America - we are heading to the world’s edge to seek our fortune. This is the only state in the world with nine defaults, and just a hundred years ago, it was more prosperous than Japan and France.

In this country, Onassis accumulated his initial wealth, and the birthplace of Pope Francis and its presidents are on speed dial for IMF officials. We are talking about Argentina, which has an excellent demographic, abundant natural resources, and formidable geographical advantages.

Agricultural production, extensive emigration from Europe, and close trade relations with Great Britain once made Argentina a synonym for prosperity. At one point, it was among the ten most developed countries in the world. But in 1929, its prosperity ended with the Great Depression. The combination of a global recession and worsening relations with Great Britain severely weakened the Argentine economy.

Since then, Argentina has been moving in a zigzag pattern - two steps forward, two steps back. Politically and economically, it oscillates between extreme right and extreme left regimes.

Despite all its natural and demographic advantages, Argentina unwaveringly follows the cycle of creation - destruction. It is no coincidence that economist Simon Kuznets said the following about it:

The world has four types of economies – developed, underdeveloped, Japan, and Argentina.

Japan is a worthy companion to Argentina in the above quote but for different reasons. One of the articles in this series will be devoted to Japan. Despite all the negative records, the Argentine economy follows an (almost) specific model - after every brutal decline, there is a robust rebound.

In 2018, after the election of the current president and the onset of another crisis in the country, the MERVAL index collapsed by over 80%. Since then, Argentina has defaulted again and gone through the COVID-19 pandemic. Inflation has reached 100%, and the peso has depreciated by 90%.

In 2022, positive signals for recovery began to emerge - the IMF restructured Argentine debt, revenues from agricultural exports and mineral resources increased, and reforms were introduced to facilitate the development of ore deposits.

Quietly, one of the strongest indices for 2022 is the MERVAL (denominated in USD). An ETF on MSCI Global X on it broke a 5-year resistance level:

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The apparent cyclicality turns the Argentine economy into an asymmetric investment opportunity.

In the coming years, several factors could propel the Argentine economy upward:

·??????Vaca Muerta - the "Dead Cow" can potentially transform the Argentine economy. This is not a vegan paramilitary organization but one of the largest shale gas deposits, rivaling the Permian Basin in the United States.

·??????October 2023 Elections - if a right-wing president is elected, the new economic course will likely be pro-market. Argentina urgently needs reforms that stimulate local businesses and foreign investments.

·??????Core to Periphery - the flow of capital is shifting from the center (United States) to the periphery (Japan and Emerging markets).

Understanding the present lies in the past, and the processes that have led to what is happening today began much earlier than we think. We travel back to colonial times and dig into the history of the Iberian Empire and the British Empire, and they both profoundly impacted Argentina`s destiny.

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Latin America and Argentina – History and Geography

Latin America (LATAM) has a dual nature – it emerged from European civilization, but at the same time, it is so different from it.

The characteristics that define Latin America and Argentina originated in its colonial past. They arose from the first global colonial powers – the Spanish and Portuguese empires. Their cultural, political, and economic characteristics are transferred to the new territories.

Over time, these characteristics evolve, but they remain the same at their core. To a large extent, they explain LATAM peculiarities. I will examine Latin American characteristics and how they impact Argentina`s present.

·??????Cultural influence – Iberian, African, and local. In different countries of the continent, one of the three groups dominates the most. In Argentina, the Iberian and European cultures, together with other factors, form the current character of the country in every aspect.

·??????Authoritarian-oriented—The Spanish empire was an absolute monarchy, and power was concentrated in the Crown, which authorized the local oligarchy through patronage. The principle of concentration of power has been preserved to this day—the current form of government in LATAM is the presidential republic, and Argentina is no exception.

·??????Egalitarian nuclear family – all sons share the inheritance equally, and daughters have no right to inherit. This family structure is typical of the Iberian Peninsula, Italy, and southern France, and later transferred to Latin America. The Roman Empire was the first state to widely accept it. This structure is one of the leading factors in the formation of macho culture. It, in turn, produces many prominent leaders and, in many cases, brutal dictators.

·??????Mercantilism in Action – the Spanish Empire followed the principles of mercantilism. The latter was a leading economic policy in Europe until the VOC and the Dutch Republic emerged. Europe mostly adopted capitalism in one way or another, but Spain adopted mercantilism as the leading economic philosophy for a long time. This is one of the reasons for its collapse as a world power in the early 19th century. In a few words, mercantilism preaches the following:

The economy is a zero-sum game – your gain is another one’s loss, and there is no place for increasing productivity. Gold is a means to an end and the end itself.

Today, the concentration of capital and a zero-sum economy is commonly found locally throughout the region.

·??????Low level of literacy – the concentration of power in the hands of a few people requires the majority to be illiterate. In other words, the subjugated majority must not be literate beyond what is necessary. In the long run, low literacy is a factor that directly affects innovation. In the case of Spain, it led to their lack of innovation. Low literacy significantly impedes the progress of any country. The correlation between the lack of an educated majority and the absence of broad innovations is one hundred percent. This leads me to the last factor.

·??????Technological backwardness – after the Reconquista, the Spanish Empire expelled the Jews and many Muslims. Among these two groups were many enterprising traders, bankers, and scholars. Education, science, and finance came under the Catholic Church's control. When the Renaissance and Enlightenment developed in Europe, Spain remained indifferent to the new trends in science and culture, remaining under the rule of absolute monarchy and the brutal censorship of the Catholic Church. Spain lagged far behind the leading states of the day – the Dutch Republic and then the British Empire. This technological and economic backwardness irreversibly transferred to the colonies in South America.

Even after 500 years, the influence of those factors is felt across the continent. They describe the commonalities shared by all states in LATAM. In brief, those shared characteristics are:

·??????Authoritarian governance

·??????Sharp transition from right to left and vice versa

·??????Capital concentration

·??????Hyperinflation

·??????Nationalization of industries

Argentina possesses all of them – hyperinflation, capital concentration, and sharp transitions from extreme left to extreme right. The economy closely follows the political pendulum – brutal downturns followed by epic rises. Following the swing of the political pendulum, I can synthesize an investment principle for LATAM in one sentence. It is as follows:

When the political pendulum swings from left to right, buy; when it swings from right to left, sell.

Geography is another variable that determines the development of civilizations in addition to historical factors. It can be both an obstacle - extreme climate, tropical diseases, lack of fertile land - or a blessing - navigable rivers, moderate climate, and access to the sea.

LATAM and Argentina, in particular, have unique geographical characteristics:

·??????South America and Asia are the most diverse continents - climate, biodiversity, and topography. Argentina is a perfect example - rainy forests in the north, a temperate climate in the middle (a large part of the country's territory falls here), and a polar tundra in the south.

·??????The topographic characteristics - navigable rivers, fertile land, and the Andes - determine the trade routes. They, in turn, are a prerequisite for the development of the countries in the region. Argentina is exceptionally blessed naturally - fertile land, lush pastures, navigable rivers, and natural borders - on one side, the Atlantic Ocean, and on the other, the Andes.

In conclusion, history and geography are (pre)determining factors, but they are not everything. The will and the human spirit can turn disadvantages into advantages. Switzerland, Japan, and Singapore are examples of such countries. Despite the obstacles, they have turned their negatives into positives.

Positive examples in the region are Chile and Uruguay - despite the geographic and cultural constraints, they are the most prosperous countries in the area. Argentina needs to find a recipe for sustainable development. In the following paragraphs, we will delve into its past, and it will not predict the future but help us better understand the present.

History of Argentina in 698 words

Argentina and the United States are similar – both are huge countries rich in natural resources, founded by European immigrants, and geographically protected from external invasion.

Considering that, they should be in a similar position. However, the reality is different and confirms that history and geography are not the final verdicts. They guide the macro processes, but people are the ones who can change the direction of movement despite geographic barriers and historical conditioning.

Argentina experiences all the classic stages of the region—the struggle for independence, exploration of the frontiers, crisis, left-wing regime, right-wing regime, crisis, and (relative) normalization.

After gaining independence from the Spanish Crown in 1810, Argentina entered close trade relations with the British Empire. Thanks to that, the country experienced rapid industrialization—railway lines, cities, and roads were built.

The conquest of Patagonia unfolded in the second half of the 19th century. It provided access to increasing amounts of arable lands and pastures, and the Argentine economy gradually strengthened as an agricultural powerhouse.

The introduction of refrigerators allows frozen beef to be transported over vast distances. Argentina has become a leader in beef production on a global scale—eventually, significant capital flows into the country. The standard of living sharply increases, and the local elites acquire European habits. Buenos Aires rightfully deserves to be compared to Paris.

The Great Depression of 1929 is the beginning of the end of the Argentine fairy tale. Trade relations with England deteriorated, the world was in recession, and the United States gradually became the leader in beef exports.

This was followed by World War II when Argentina was formally neutral. The war coincided with Juan Domingo Perón's rise to power. As a result of the populist reforms undertaken, the economy stagnated despite short-term successes. A series of coups and national bankruptcies followed. The peak of dictatorships came during the three military juntas, which changed within a few years.

The last one under the rule of Leopoldo Galtieri started the Falklands War in 1982. It aimed for two things: financial gains due to the exceptional oil deposits in the region and a desperate attempt to save the government. The regime needed urgent PR, and the seizure of the Falkland Islands seemed like the perfect solution.

Neither of the goals was achieved, as Argentina lost the war, and its end marked the beginning of the downfall of the last dictatorship. The first democratic elections followed, leading to positive reforms and gradual economic recovery.

In the 1990s, a large part of the nationalized companies during Peron's time were privatized, and the economy became increasingly integrated, with principles of a free market widely adopted.

A deep recession hit Argentina in the century due to several internal and external factors.

The two main factors were:

·??????Internal: structural deficiencies deeply rooted in the economy and finance over the last decades;

·??????External: the debt crisis in 1998 in developing markets

The destructive synchronicity between those factors led to a severe crisis. From 1998 to 2002, GDP fell by 28%, increasing unemployment, defaulting on external debt, and devaluating the peso. All of this is a self-sustaining reflexive cycle.

The crisis was resolved under the guidance of the IMF, restructuring external debt once again. Meanwhile, the last commodity supercycle began at the beginning of the century, fueled by China's integration into the global economy.

After 2003, Argentina regained its strength. The standard of living rose, the local MERVAL index reached peak levels, inflation was relatively low (if 10% inflation can be considered low), and unemployment decreased.

Turbulent moments have not completely disappeared—the local index has fallen several times by over 80% from 2003 to the present and reached new highs. However, extreme political regimes from the past are absent, which softens these turbulences.

Argentina follows its path - hyperinflation, numerous crises, military juntas, and populist governments- all leading to the present. There is no extreme political polarization (for now). Political power swings between left and right, with Peronists (the left-wing political faction in Argentina) in the lead. Most presidents over the last decades, including the current one, come from this faction.

The political pendulum never stops moving in Latin America. In 2023, elections in Argentina are detrimental to its economic future. Three factors can revive the Argentinian economy, and the outcome of the polls is one of them.

In the next chapter , I discuss in detail all three.

This article was originally posted on my website, investo. bg on 24 January 2023.

Next week is the primaries in Argentina (PASO). These outcomes will increase or reduce the credibility of my hypothesis.

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