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Argentinians and Americans — A Study in Parallels

Is the current lack of investor confidence in the United States comparable to the agonies of middle-class Argentinians?

August 16, 2002

Is the current lack of investor confidence in the United States comparable to the agonies of middle-class Argentinians?

The agonies of middle-class Argentinians have been the stuff of newspaper articles for almost a year. Ever since Argentina's government froze the country's bank accounts when it cut the link between the peso and the dollar, many Argentinian savers have been out of luck.

Yes, they have a certain amount of wealth — in the form of bank accounts. But they can't actually tap that wealth — or spend it.

Instead, Argentina's government continues to discuss various schemes that would allow the country's citizens access to their money only under one condition.

They have to agree to take less than the one peso per dollar rate that they expected when they deposited their funds with banks before the crisis.

Oddly enough, that makes them surprisingly similar to — U.S. investors. Except that the Argentinians might just be in better shape.

During the 1990s, a new breed of investors came to Wall Street. Stock ownership expanded rapidly — and by the start of the new millennium, over 50% of U.S. households owned stocks. Most of those investments were in the form of pension funds, mutual funds and 401(k) accounts.

Those new investors came to the market convinced of a few seemingly self-evident truths. First, that you always end up making money in stocks, and, second, that the stock market keeps going up — so that dips are good buying opportunities.

Plus, since pension and mutual fund accounts are a nest egg for the future, most retail investors didn't worry when their paper holdings fell in value. By the time they retired, they reasoned, the stock market would be back at record levels.

But now, after more than two years of a bear market, and with the downward trend accelerating swiftly in the summer of 2002, individual investors are having second thoughts.

June saw investors redeem, on net, $18 billion from stock funds — the third largest redemption every recorded. July's redemption level is expected to be at least as large. Naturally, those redemption levels have helped to feed the stock market's decline.

Congress, the Bush Administration, and various federal agencies have been looking to shore up investor confidence and stop the hemorrhage on Wall Street. So far, they have met little success.

The problem is simple: With faith in stocks dropping every day, U.S. investors are pulling their money out of the market. All of that actually sounds an awful lot like what happened in Argentina.

During the 1990s, Argentina's currency board let Argentinians believe that their money would be safe in pesos. After all, they were told, you could always switch your pesos for dollars at a one-to-one rate.

That faith allowed Argentinians to keep their money in pesos — a sharp contrast to the past when, crisis or no crisis, any and every bit of wealth was immediately put into foreign currency.

But, by last year, that faith had eroded in Argentina. And as people began exchanging their pesos for dollars, the government was faced with a dilemma.

Since it didn't actually have enough dollars, it needed to either borrow the U.S. currency — or change the law.

Ironically enough, it was the action of the U.S. Treasury — in denying Argentina a loan in November 2001 — that created the final crisis.

The response of the Argentine government was to freeze bank accounts. This effectively prevented the continued drain on the country's foreign currency reserves.

Then, the government permitted the peso to float freely against other currencies. Of course, the peso promptly sank. Within a month and a half, it had lost half its value.

That allowed the country to weather the crisis (sort of). But it left Argentinian savers holding bank accounts that they could not use.

Worse, it is unlikely that the money will be returned at the exchange rate the savers originally expected — one dollar to one peso. Valued in dollars, the wealth of middle class Argentinians was decimated by the financial crisis.

The wealth of U.S. savers is now also being decimated via the stock market. And the U.S. Treasury has fewer tools to slow down the losses than Argentina did.

It is far-fetched to imagine that the U.S. government could freeze mutual fund redemptions — or switching out of stocks. That would be the functional equivalent of Argentina's action.

In the perhaps fortunate absence of such powers, about all the U.S. Treasury can do is what the Argentinian government did before 2001.

That is to remind U.S. savers that the economic system is fundamentally sound — and that their money will earn more in the long run if it stays in the stock market.

And the U.S. Treasury — and U.S. savers — had better hope that the parallels with Argentina end there.