While in December 2001 much of the world was enjoying the holiday season, Argentina was encroached in their own ‘ice-nine’ hell.
If you are not familiar with ice-nine, it’s a term Daily Reckoning’s Strategist Jim Rickards borrowed from the novel Cat’s Cradle, to explain how our financial system could freeze up in the next financial crisis. It’s a scenario I was familiar with when I read Jim’s book, The Road to Ruin.
You may have heard of the deposit freeze in 2013 in Cyprus, but well before it happened there, it happened in Argentina.
In Argentina though, we called it ‘corralito’. This comes from the Spanish word ‘corral’, which refers to the enclosure where we keep farm animals in. In the corralito’s case though, the enclosure kept Argentinians’ money secured inside the banks.
It was a crisis that had been brewing for a while.
The country had been fighting against inflation and hyperinflation, which had eaten up salaries and caused riots and lootings.
To keep the value of their money, people were exchanging the Argentine austral for US dollars. It’s a vicious cycle though, because the more people sell the local currency, the more it devalues.
So, to create economic stability, the government changed the currency from australes to the Argentine peso and pegged it to the US dollar. That is, AR$1 equalled US$1.
This succeeded in stopping hyperinflation. It also meant that people could hold bank accounts and even get debt in US dollars.
But this came with a high price tag.
It made imports cheaper and Argentinean exports more expensive. To maintain the peg, the country had to keep on borrowing, which increased foreign debt along with the amount of interest the government had to pay for that debt.
By the time 2001 came around, it was clear that the peso was overvalued.
But after having lived through hyperinflation, Argentinians didn’t want to leave the peg. They saw it as a solution against inflation. So, Argentina kept borrowing to sustain the peg, and fears that Argentina would default from its debt kept rising.
In December, the International Monetary Fund blocked a new loan after the country didn’t achieve its goals. With no money coming in and fearing a loss of confidence, on 3 December 2001, the government set the ‘corralito’ in motion. Banks closed their doors to prevent a bank run.
People were only allowed to take out US$250 a week to cover expenses. And they faced large bank queues to be able to withdraw even that small sum.
The corralito paralysed the country and the economy.
Tensions ran high too, with riots and protests all over the country.
The ‘cacerolazo’ — where people banged pots and pans inside their houses — became a symbol of the protest and the deafening noise could be heard all over the capital.
Over the next 10 days three different candidates became president. Every single one of them failed.
In January 2002, Eduardo Duhalde became the new president. He abandoned the peg and set the new exchange rate of AR$1.40 pesos to US$1.
But it was clear that, even at the rate of AR$1.40, the peso was still overvalued. The value of the peso kept falling to reach almost four times lower than its original value.
At this point, you need to bear in mind that people still cannot access their money.
They have no idea when — if ever — they’ll be able to access their life savings again. And even then, they have no idea how much there will be left when they do, as they watch their savings devalue against the US dollar.
In the end, it would take them a whole year to access their deposits.
The biggest losers were small savers and pensioners, amongst them, my grandfather who had his life savings in a US dollar fixed-term deposit.
Another victim from the corralito was my younger brother, who at the time was in his first Uni year in Los Angeles. The large and sudden devaluation of the peso against the dollar meant that he had to stop his studies and come back home.
Argentinians have learned the hard way what an ice-nine style scenario can do to your savings.
Here we are now, all together battling against COVID-19.
Things weren’t good before the pandemic
This pandemic has managed to halt the global economy and is accelerating trends we were already seeing. But as I wrote last week, things weren’t good before this outbreak.
Australia is the ‘lucky country’. So far, it has managed to avoid a recession for an incredible 29 years.
But I can’t stop thinking about what could happen next.
Unemployment keeps going up. What happens when people can’t pay their bills?
Overnight, Fitch Ratings downgraded Australia’s Big Four because of concerns with increasing unemployment and low profitability.
Australian banks are also exposed to property, a market that has come to a grinding stop.
And then, there are the dangers of spillover economic effects from other countries.
I’m not telling you all this to anger you or to create a panic. I think overall our government is doing a good job and are handling quite well a really hard situation.
My whole point in telling you about my family’s experience is to show you how quickly the system can close up.
Or even change.
We’ve already seen quite a bit of panic in this crisis…toilet paper…gym equipment…even gold. If you go to the Perth Mint’s website you’ll notice you can’t buy already cast and minted gold bars.
And, have you noticed? Cash is fast becoming the undesirable. Many stores are already not taking cash anymore, and banks are egging us to use their online services. COVID-19 could very well be the thing that eradicates cash.
Could we see an ice-nine type scenario? I think it’s a possibility.
It’s certainly a reason to hold some physical gold, and cash.
We could even be witnessing a change in monetary system, a reset. It’s something Jim has been predicting for a while.