The sight of harvesting machines, highly capitalized farmers participating in commodity futures markets are completely foreign to a hyper inflationary scenario. Such a sight belongs to farming under stable relative prices and available credit.
Please, click here to read this article in pdf format: January 8 2013
This is my first letter of 2013. I was not able to write earlier as I was travelling in Argentina. The situation there is complex and fluid. It would seem easy to compare it to that of Venezuela, but that would be a dangerous reductionism. Three things really caught my attention and are related to what we are going through in the developed world:
a) Argentines, just like everyone else in this world, struggle to find acceptable assets to allocate their capital. This is striking because they have no capital markets and it would seem that real estate or the US dollar should be the no-brainer, natural alternatives. Yet, unlike in the past, they are not. However, the reasons for this go beyond the scope of today’s letter.
b) In spite of explicit acknowledgment by the Argentine government that the monetary base will grow at no less than a 40% per year (this is even embedded in the government budget projections), the government still manages to issue its currency. The country is still far from hyperinflation, although with high inflation. There are no definitive metrics given the media repression, but private estimates gauge it at no less than 25%.
c) Just like some analysts today see a bubble in the price of gold, there are analysts in Argentina who see a bubble in the price of the US dollar vs. that of the peso. This is a country that has gone through two hyperinflations and decades of high inflation within a single generation. I was astonished to see how easily the memory of all this was lost. This is so impressive that even Roberto Cachanosky, a leading Austrian voice in the country and who regularly writes at La Nación, had to devote one of his weekly columns to “explain” that the US dollar was not in a bubble.
Why do I bring this up? Because I still can’t find what the difference is between Ben Bernanke, who is telling me that he’s going to monetize US sovereign debt as long as the unemployment rate (as measured by the government) is not below 6.5%, and Mercedes Marcó del Pont who openly says that monetizing debt does not lead to inflation (as measured by the government) and that the Banco Central will monetize all the sovereign debt necessary to boost economic growth. As much as I hate acknowledging this, I am convinced Cristina Fernandez de Kirchner is right when she says that the developed world lacks the moral authority to criticize her policies.
Real estate under high inflation: Context and assumptions
Let’s return now to the topic of the day, namely real estate as an inflation hedge. Today, I want to offer my family’s experience in the case of Argentina’s hyperinflation and their choice of real estate as the hedge against it. The context in which this story takes place is one of high inflation, in which the market knew two things: a) It was a point of no return, and b) It was going to get worse before it would get better.
I think it is clear that none of these points are visible today in the developed world. For instance, gold was sold last week simply because the FOMC minutes suggested that the same Fed that has to buy approx. 90% of the Treasury’s long-term debt issuance to keep rates from rising (without much success one must add), may end the purchases by the end of this year.
The context of the story was also one of increasing financial repression. As I suggested earlier, inflation and financial repression are only two different sides of the same coin. And as inflation spikes, so do interest rates, for the trust in the system collapses. Only with higher rates can central banks sustain a target level of deposits, so that the coerced banking system sources the funds needed to buy sovereign debt. High nominal interest rates and inflation then, go hand in hand.
In such a context, there is no return and the market knows it will get worse. The fear of confiscation sets in. Confiscation can and did take place in two ways: a) Between private citizens/corporations, in which case, we are in the face of explicit wealth transfer from creditors to debtors or landlords to tenants, and b) from private citizens/corporations in favour of the state.
A true story
In 1973, Argentina decided to nationalize bank deposits and to impose a 100% reserve requirement. This measure however was not to last long and by 1976, the banking sector was again allowed to leverage on its deposits. To fight the increasing exodus from the system by depositors, the central bank decided to encourage deposits by paying interest on savings accounts deposits and charging a fine on current account deposits. By 1980, 90% of all deposits were in savings accounts under 90 days and the average lending rate was 35%. This brought about a spiralling quasi-fiscal deficit (i.e. a deficit at the central bank) that led to the hyperinflations of 1985 and 1989 (Read more about this –in Spanish- here)
It was in the context described above that my father first lost his first apartment and later bought a ranch as a hedge against the increasing inflation. The apartment in Buenos Aires was lost to a tenant, in the early 1970s, who took advantage of a new bill favouring tenants over landlords. That apartment was my parents’ first home and they had only vacated it because they were working outside Buenos Aires at the time. It was not their investment property. My father ended up negotiating a ridiculous discount to at least get something back, but he basically lost it all. There is really not much more to say in defense of the investment-in-condos thesis as a hedge against inflation (Remember that if rental contracts at one point, given high inflation, become denominated in a foreign currency or gold, the government will very likely fix the price of these assets (i.e. fx, gold) at an official rate, below the proper market prices. Landlords will receive that official rate and will not be able to challenge it in court).
In 1978, however, my father did purchase a ranch for investment purposes, in beautiful Patagonia. Today, I want to share this experience, vis-à-vis the thesis held by Jim Rogers because my father back then thought like Mr. Rogers today.
The Jim Rogers thesis
Briefly, Jim Roger’s thesis is old and simple: The monetization of sovereign debt means higher commodity prices and owning a farm is a means to both profit from these higher commodity prices and protect one’s capital, invested in land. In Jim’s words, farmers will drive Lamborghinis.
Well, it may be true in the early stages of a hyperinflationary process. But as inflation arrives to stay and the money printing becomes structural, the financial repression that follows challenges the thesis. As well, just like in the first world today newer taxes or higher tax rates are being imposed on those lucky enough to be able to save and invest, back then politicians engaged in demagogy and established new laws to favour debtors and tenants over creditors and landlords. In my experience, under high inflation, the price of agricultural commodities rises in local currency terms because of shortages in production. There are shortages because producing is not profitable. Rising nominal prices therefore are not a signal to encourage production, but precisely the opposite; the reflection of supply shortages because producing is unprofitable. The unprofitability, of course, is caused by the government’s intervention via price controls (wages, foreign exchange), higher taxes, trade restrictions and outright confiscations. To expect that farmers will be able to receive international market prices for their produce under high inflation is naive at best. I know of no nation under high inflation, where its government would have not controlled exports (or their prices) of necessary goods (i.e. food), or forbidden imports of luxury goods.
The case of “Los Maitenes”
My father bought Los Maitenes (the name of the ranch) in 1978 with the simple idea of protecting his capital. He was not a rancher, although he knew the business well from my grandfather (who had managed an estancia for Mr. Bunge in the 1920s). Indeed, it was not a farming property in the sense Jim Rogers means: It is in the mountains and is for the purpose of raising cattle. Growing grains there is not efficient. However, whenever the price of grains rises (in US dollars) and the agricultural frontier shifts to the West, land formerly used for cattle in the Pampas needs to find a replacement and ranches in Patagonia get bid.
To my father’s disappointment, rates and the appreciation of the US dollar continued to outperform ranching. Under high inflation, soon everyone wanted to own (“stock up” would be a better word) products, but not producers. Nobody was interested in producing anything and it was not due to some behavioural problem, as Keynes and its followers always point to. Simply, the distortion in relative prices and the disappearance of credit for working capital (i.e. nobody in the business of “making stuff” could any longer reasonably calculate whether they did so at a profit or at a loss) was too high to bear. My father then became a forced long-term real estate investor. Nobody was interested in buying him out of the ranch. It was far better to keep playing the dangerous game of earning absurd returns in savings accounts deposits, subsidized by the central bank, or to keep your capital in foreign currency, fully liquid. It was a game that would last until 1989, when deposits in savings accounts were confiscated and paid back in bonds. In my view, we can see this same phenomenon playing out further down the road of this ongoing inflationary process, whereby gold would play the role the US dollar played in Argentina.
In the meantime, my family had managed to survive from other income sources until 1981. In that year, their most important source, a concession on a beach resort in Mar del Plata, was finally expropriated under the regime of General Galtieri. The thesis that owning a ranch was the final hedge against inflation and general chaos suddenly became a reality and in January 1982, my father set off to Patagonia. It was a three-day long trip with a trailer (see picture below). In this trailer, we would live the first three months.
Picture 1: A stop on the way to Los Maitenes, January 1982 (I am on the right, next to my mother and sister).
A few months later, war broke with the UK over the Falkland Islands. Living in Patagonia, this meant that everything could be taken from us at any moment, if either the UK or Chile invaded. Fortunately, this scenario did not play out. However, during that first year at the ranch, my father found out that squatters were living in different parts of the property. Once again, even though he managed to negotiate a settlement with some of them, the government expropriated a few hectares from us. I am sure Mr. Rogers did not take into account this sort of inconveniences, but expropriation becomes very real when credit disappears and food shortages follow. As I wrote in my earlier letter,”…thousands of years of Diaspora are screaming to us in the face that the advantage of gold as an easy-to-transport and store asset is not to be underestimated…”
From 1983 on, inflation began to grow exponentially. Soon, it became difficult to know if one was making or losing money. Relative prices in terms of US dollars fluctuated widely and in general, over the long term, everything tended to depreciate versus this currency (just as I expect prices to continue depreciating in terms of gold, if QE remains eternal). Without liquidity and credit, farmers began to barter. The most liquid items were alfalfa hay, flour, wire rolls, gasoline and meat. Contracts could be settled in alfalfa bales, 10-kilo flour bags, fencing wire rolls (1,000 meters per roll), and litres of gasoline or kilos of meat.
Bartering, my father survived those years. He hired men to plant, irrigate and harvest the alfalfa lots in the ranch, on a partnership basis. Whatever alfalfa bales he managed to keep, he used them to further buy cattle or to pay for labour. The cattle were then bartered at the nearest general store to buy groceries. Anything outside the bartering circle became extremely expensive (clothes, fuel, electronics, etc.), as cattle or alfalfa bales had to be first exchanged for currency.
The years of high inflation were years of self-sufficiency. It took us about seven years to build our house, for we had to produce our own bricks (adobe), stucco and wood. Below is a picture worth a thousand words: In it, we see Don Onofre Grandón, carpenter, working a poplar tree just cut down at the property to produce one of the rafters for the roof frame of our house. Circled far in the back, we can see a stock of adobe bricks also produced at the ranch. This picture was taken on January 1989, during the last hyperinflation.
Picture 2: House building under hyperinflation
The picture above is comparable to a painting of the London’s Carpenter’s Company in the late Middle Ages. Any European peasant resuscitated from the Middle Ages would immediately recognize and feel familiar with this scene. This is a typical scene of a farm in times of hyperinflation. And it makes perfect sense: Under the Pax Romana, the owners of villas were rich. When hyperinflation finally destroyed the Roman Empire under Diocletian, owning a villa was a liability, as one could not trade the produce without price controls or safe transportation and was further subject to either looting by barbarians or confiscatory taxation by Rome.
The above picture shows a scene of non-monetary exchange, no access to a Home Depot, no credit, no capital markets nor commodity markets (either spot or futures). The sight of harvesting machines, highly capitalized farmers participating in commodity futures markets are completely foreign to a hyperinflationary scenario. Such a sight belongs to farming under stable relative prices and available credit. Eventually, both came back after the peso collapsed and became convertible to the US dollar, in 1991. It was only after the hyperinflationary episode, when the peso as legal tender was fully repudiated, that farming became again a productive enterprise, when the government had no choice but to become friendlier to open markets and seriously diminish any form of financial repression.
Epilogue
The story I just shared is definitely not what Jim Rogers has in mind. During those years, holding US dollars or taking the risk of financing the government with deposits at the banks far outperformed any productive project. However, at one point (in 1989), even financing the government ended up a losing proposition, and term-deposits were confiscated (see the announcement of the confiscation here)
US dollars (or any other stable foreign fiat currency), in the end, were king. When I extrapolate my personal experience to our current situation, I feel confident that holding physical gold to the end will also be the winning strategy. Hence, my disagreement with Jim Rogers: Farmers will not drive Lamborghinis if inflation spikes.
During those years, the government constantly sought to manipulate the price of the US dollar or to discourage everyone from holding foreign exchange. This too is happening with gold and I expect it will become more pronounced in the years ahead.
Martin Sibileau
January 8th, 2013 at 6:37 AM
It’s always good to learn from someone’s real life experience and not just from theories.
Nevertheless, do you think Argentina’s case is a bit on the extreme side of things?
January 8th, 2013 at 8:00 AM
Dorky, every case is different, indeed. But the key take away here is that under high inflation, with the destruction of money as a medium of indirect exchange, social cooperation is seriously affected. Hence, farming becomes a medium to survive, to at least guarantee self-sufficiency. Farmers cannot export, cannot get the benefit of international prices, trade collapses, the ability to purchase equipment is significantly impacted and productivity falls. That has occurred everywhere, in different degrees of course, but it did take place nevertheless: In Egypt and the rest of the Roman provinces at the fall of the Empire, in Zimbabwe, in the former Soviet republics, in Argentina, in Bolivia, etc. So…no Lamborghinis!
January 8th, 2013 at 8:18 AM
Are we seeing the step 4 of the inflationary path with the steeper curve, that is the increase in capital expenditures?
January 8th, 2013 at 5:08 PM
It is now almost four years that discovering, litterally from zero, about the existence of Mr. Ludwig Von Mises thanks to a mises daily found out searching about alternative 2008 crisis explanations to those by me perceived no more credible (at the time Mr Dick Green at Briefing.com insisted that the subprime crisis could not derail significantly nor american economy neither the global economy: the theory affirmed was that housing was only perhaps 10% of the US gdp while, for istance, financials were a bigger share and thanks Bernanke we could fly away from crisis: knowing nothing about what really was beneath the iceberg of subprime crisis anyway managed to find out myself a lot of dissatisfacted with the comforting MSM vommentary of the moment notwithstanding for me no one still had provided a so necessary clarification about my really confounding economical background from University..at Pavia, Italy Mr. Professor Mori assigned to me one of my best score in an exam, Political Economy II for my acquired discrete skills in explaining the exchange rate determinants..the problem was the content..there names like Mises, Rothbard, also Hayek seemed completely unexistent on the face of world but strangely enough Keynes ..they know existed and they had that kind of stuff to teach me!!
Sorry Mr. Sibileau I take your precious attention with some biographical notes from me but, seeing your heroical ones today after about four years I follow you always deeply grateful and concentrated to catch your thoughts at my best, I was inspired finally to give myself a comment to your very good explained points: it seems to me you are a so good man before you are probably a so good economics blogger and you, also seems to me a really austrian (rothbardian?) economist but better you confirm me this for sure; anyway on your economic point of the last two letters – if hyperinflation has to come ruining our lives in this decade farmers will not drive Lamborghinis you are really correct..confiscation will be the word of the day not good earnings in farming we see already at the moment – here in Italy – with a new wave of inflation coming (after the really more than doubling of prices at the supermarket in just the six years 2002/2007 with prices already in the assumed strong money euro!)a first tasting of wath it really mean for the producers in building sector especially – being suddenly denied just the manteinance of the old credit lines..here about 20/30 % I estimate of the building sector was in trouble of bankruptcy since 2009 the problem is, that we still have that % of bankruptcies to realize after 3 full years in this crisis but in the meantime they have – horrible to say but that is what I believe it is happening in Milan hinterland and so on – managed to transfer the bad public credits from the old bunkrupted but strongly banked big building firms to the new entries that now begin to find out they had been driven toward very bad deals and are the real firms that will be called by their creditors but almost nothing they will recover from their credits with so many bunkrupted public entities (in Italy State than Region than Province and finally the County all they are so indebted all they will be totally incapable to front their debts in the next terrible years but horrible to say, first of all, they will manage to send to bankruptcy before them, so many perfectly working, really working, italian private firms!) ..so I humbly want to confirm you, Mr Sibileau, that here in Italy were Mr. Mussolini got so much credibility after about 20 years of total corruption and trasformism of the start of ’900, a taste of the confiscation to come we already have..for what could I call otherwise this malefic banking tecnique consisting in transferring bad quality credits at par to unknowing preselected victims (little private firms in many sectors not only building) keeping alive for many years really broken customers just because they happen are the ones privileged by they creditor banks that have managed to mantain full their financial resources thanks to mr. Trichet/Draghi: they are already confiscating the entrepeneur private success leaving it to bear the debt of others!!! Banca Intesa or Unicredit the biggest banks in Italy would have to bear those debts ceasing to incestuosly buying btp after btp but italian government before and bce now have managed to convince this bad people to conspire against the real italian little entrepeunership.
A really felt good bye,
Massimo Mainetti, Samolaco 2013/01/08
P.S. Keep the good work on!
January 8th, 2013 at 8:03 PM
Martin, if you are preparing again for a repeat of the hyperinflation, where would you keep your physical gold? home, storage? What about defense? Would you own any type of income property – unlevered? Thanks Charles. PS great site.
January 9th, 2013 at 12:00 AM
Molte grazie, Massimo!
January 9th, 2013 at 12:08 AM
Charles,
Thanks for the comment. I don’t really know where I would keep the gold, but you want to keep it close and safe. Income properties are for stable times and sound money. Under high inflation, governments very often put caps on rental prices, allow tenants to renegotiate contracts and eventually, to even stay for free if they are in need. Property prices fall under high inflation, because high inflation always comes with repression, and everyone wants to stay liquid (in a hard currency or gold).
Cheers,
M.
January 9th, 2013 at 5:17 AM
Martin,
A fantastic article — thanks for sharing your experience.
Aside from gold, what other assets would you consider? For myself, I have:
* purchased / refurbished / sold property in “haven” (ahem…) countries like London, UK
* moved cash into Singapore dollars, in offshore (i.e. non Canada / US) bank accounts
* US preferred equities (though this market is now bid up and its time to exit)
Any ideas you are willing to share?
Matt
January 9th, 2013 at 10:58 AM
Thanks, Matt. I think it is time to focus in how you will generate income under high inflation, rather than how you will protect your assets. Protecting assets is the easy part: Choose something easy to TOUCH and own, store, hide, transport, and with global acceptance. I think I said it all. To generate income, you want to have the ability to increase your revenue nominally in local currency, as inflation spikes. Most likely, trade with the rest of the world will be heavily impaired or over taxed. Therefore, in high inflation, you don’t want to be employed, but run your own business. Your business should not employ fixed, real capital, because it depreciates and requires replacement and replacing your capital will cost you hard currency. Also, you should be able to have a tight control on your operating margins. You should not depend on public infrastructure (roads, railroads) for delivery of your product, because they will collapse for lack of funding. In other words, it will be a good world for lawyers, doctors, accountants, and all those professionals who sell their brain work directly to clients. I would not like to be an engineer, if high inflation sets in. Cheers,
M.
March 16th, 2013 at 7:27 AM
Dear Martin Sibileau,
I really like you and respect your insightful writing as well as admire your personal story. Still, I believe that these who argue with Jim Rogers are wrong because they have no idea what he means.
He usually gives general directions and advice which are almost always right but depends on the interpretation and time. When Jim is saying that farmers will be driving the Lamborghinis, he doesn’t mean that it will happen everywhere in the world, but that this will be the best place to put money in general. He wants to emphasize not on the asset that will perform best during hyperinflation but during high inflation as in the 70s in the USA or in high inflation years in the UK, when really the farmlands did a killing.
He doesn’t say, that Argentina or a country experiencing a total economic ruin will be a good place to park money in farmland. He doesn’t say, that one should become a farmer in Antarctica or in Iran. He is definitely not insane and knows what a movable asset means, as well as taxation, productivity, bans and confiscation, probably better than anyone unless they are historians and worldwide investors for 40+ years.
His thesis is about the bull market in commodities and that even with high oil prices, farmlands in the right countries will really turn farmers into very rich people. If we also look for the best long-term annualized returns, farmland was and will continue to be the best place to invest. In fact its already happening in many countries. Of course it can’t happen in Zimbabwe or some countries heading for a total financial ruin. I’m not going to argue why USA will not experience hyperinflation, nor that farmers will not be taxes more, but I would believe that if one is to invest today for the future, he or she should look for productive assets in the right countries and for me the most important and best productive asset during a agri-commodities bubble will be farmland. As for the right countries, this is something that everyone should decide depending on many factors.
I believe that the world and commentators still have no idea what Jim means and usually interpret his words with a great deal of skepticism and misunderstanding.
March 16th, 2013 at 8:38 AM
@Iliyan,
Thanks for your comments. I understand your point of view very well. Being very familiar with farming myself, I am also aware that farming is highly capital intensive, even in Argentina. If it is highly capital intensive in Argentina, I can’t even imagine how much more intensive it is in North America. When inflation picks up, any capital intensive activity suffers. That is my main point. Farming is horribly sensitive to working capital, outsourcing of planting and harvesting. If farmers don’t outsource, they must therefore have enough scale to be able to afford the debt needed to purchase machinery themselves. Where is that debt going to come from? At what price?
If commodities picked up and a rush for physical or the repudiation of Treasuries affected the solvency of a clearinghouse and the respective hedging taking place there, the ensuing price volatility would also impact farmers. And if they still remain profitable after all this, then they will be easy prey for the taxman. Thinking that such scenarios would not be possible in the first world and are only possible in Argentina is not prudent. Only twenty years before all this occurred in Argentina, nobody would have ever imagined that this country had nothing else but a bright future awaiting. If you would have asked in the 1950s which countries were to win the XX century, Argentina would have shown up together with Australia and Canada. When my father bought his farm in the 70s, it was not at all clear that Argentina was going to end up in total ruin. This only started to become evident in the ’80s. And I really challenge your notion that farming under inflation is more profitable than under price stability. The evidence I have found is completely in favour of sound money.
Regards,
M.
March 16th, 2013 at 11:10 AM
Jim is not giving an advice to people to use leverage, buy farm and equipment on debt (have a year of bad weather, or price volatility and get killed). Here we talk about someone who put some cash to work today.
In Bulgaria, costs of self-funded farmer are 25% of the revenues per acre. By self-funded I mean, farmer who doesn’t pay rent and credit, interest for farmland or machinery. Wages are low and even an increase by 100% won’t make any different as a effective farm of 750 acres needs no more than 4-6 people who represent just 4-5% of the total costs. The only costs left are for oil, fertilizer and seeds but they go up when food prices go up.
What I know is that farming is good in price stability and low to medium inflation for self-funded farmers. Of course under hyperinflation the rules of life are different. We also experienced hyperinflation in 1997.
When it comes to food price volatility, this is again a problem only for leveraged, not self-funded farmers. Which is usually good for farmers who survive the year (as there is less food supply) after that. In Bulgaria we have 10% flat corporate tax. Could it go up to 30%? Yes, but farming will still be profitable for some. As with any market, noncompetitive and leveraged participants will just go away.
Not only this, but if farming suffers because of high interest rates and debt, there will be less food in the supply chain and because of the demand and low inventory levels, prices will shoot, leaving people who are self-funded to take the gain provided by the high food prices. If you check the farming business in the 1970s in the USA, you will see that under high inflation, farming was the best business, farmland prices increase 8 times until interest rates went too high 15%+, to pop the bubble (not as today 0%). Of course the bubble didn’t pop until the inventory levels weren’t high enough. It wasn’t a business for a year or two. I’m also an advocate for price stability but I don’t see such. When I check the inventory to consumption levels, and I see how every year with bad whether sends food prices 70%+, I just can’t smell how this bull market will end today.
Regarding your point that Argentina’s problems couldn’t be predicted, I’m sure there are some people who saw it coming. I’m not saying that I could or that the macro game is easy but that there are some people who see many years ahead and when people take an advice as the one of Jim, they have to better know what he means and do their research.
Sincerely,
Ili
March 24th, 2013 at 3:54 AM
Martin,
It seems to me that the assumption that the U.S. will follow the path of Argentina is tenuous. I realize that most socialist and fascist systems have similar patterns, however, there are probably cases in history where holding gold could be punished by death or imprisonment.
Seems like having a very small farm where one could grow some food for barter might be a safe course. I do agree that owning a large farming operation with many employees and a large yearly capital requirement would be dangerous.
Any thoughts on silver? Silver might not be such a large target as gold.