Now, Chavez’s aggressive economic policies are again being called into question, this time as the country slides into what could be a protracted period of stagflation, which is defined by the exasperating mixture of torpid economic growth and high inflation.

Before that, however, the period from 2004-2007 was marked by rapid economic growth – punctuated by a miraculous 19.42% burst in 2004. Since that time, unfortunately, Venezuelans have watched as their standard of living was slowly eroded by restrictive price controls, rapid inflation, unsustainable public spending, and widespread nationalizations that have put a stranglehold on industry.

Even as these problems festered, an unprecedented surge in oil prices allowed Chavez to maintain his questionable – and ultimately unsustainable – economic policies. When the bull market in commodities abruptly stalled last year, Venezuela’s economy lumbered to a stop.

Venezuela’s economy grew by 3.2% in the fourth quarter of 2008 and just 0.3% in the first quarter of 2009. Then – for the first time in more than five years – that country’s economy contracted, shrinking 2.4% in the second quarter.

Unfortunately for Venezuela, the decline in gross domestic product (GDP) did little to quell surging inflation.  The annual rate of inflation climbed to 26.2% in July, according to the Central Bank of Venezuela. Many foreign sources have it higher.

President Chavez insists his country is not in the midst of a financial crisis, but analysts believe this is just the beginning of a bad-news saga that will trip up a country whose heavy-handed economic policies have made it few friends.

“To sum up, we could say that such scenario of stagflation has two basic components,” Orlando Ochoa, an economist and professor with Andrés Bello Catholic University (UCAB), told El Universal. “On the one hand, price control, exchange control, nationalizations and restricted distribution of foreign currency damage supply. On the other hand, lower oil prices curtail revenues and have an impact on demand.”

Going forward, Venezuela’s currency controls are perhaps the biggest hurdle for the economy to overcome. Chavez and his cabinet have said they are preparing to announce measures to stimulate the economy, but that may not be enough.

The problems that come with over-reliance on oil and a vast net of unwieldy social programs and the cost burden of nationalized industry aren’t going anywhere. And the nation’s other obstacle – the gap between its official and parallel exchange rates – won’t be addressed until at least the end of September.

An Unparalleled Problem

Indeed, the problems facing Venezuela are many. But President Chavez and his cabinet believe they have the solution.

“There is a remedy,” Venezuelan Finance Minister Ali Rodriguez said in an interview broadcast on state television. “The differential between the official dollar and the [so-called] ‘parallel dollar’ can be reduced.”

Rodriguez was referring to the difference between the country’s “official” exchange rate – which remains at 2.15 bolivars per U.S. dollar – and the so-called “parallel market,” which suggests a rate of about 6.5 bolivars per U.S. dollar.

The official exchange rate of 2.15 bolivars per U.S. dollar was arrived at in 2003, when Chavez imposed currency controls that force Venezuelans who want to import goods to apply for a government permit. Importers that are unable to get permits to buy currency at the official exchange rate have been forced to turn to the parallel market, where they pay three times the official price.

The problem now is that a large drop in oil revenue has sharply reduced the amount of dollars the government has available to exchange. That has driven more importers to the pricier parallel market. Some have stopped importing entirely.

With limited access to imports, Venezuela’s manufacturing sector contracted by 8.5% in the second quarter.

“The manufacturing sector is going to have a negative performance, mostly because of the restriction in imports and dollars, which has caused a drop in the supply of primary materials,” Miguel Carpio, an economist at Banco Federal CA in Caracas, told Bloomberg News. “Add to that the drop in consumption, and this is going to be a very difficult year.”

Now, with the threat of stagflation looming large, Chavez has no choice but to take action. But economists are unsure of what the government will do.

Few analysts expect the government to order an outright devaluation, because it would push inflation beyond the 28% annual rate. (Venezuela last devalued the official rate in 2005, weakening the currency by 11%.)

Instead, the government could try to lower the parallel rate by issuing dollar-denominated debt, by creating a second, separate exchange rate for “necessary” industries, or by doing both those things.

Traditionally, the government chooses to subsidize certain favorite industries – mainly heavy machinery, foodstuffs and medicines – by allowing them to trade bolivars at the official rate and driving other non-essential goods producers to the parallel market.

This could be taken a step further by imposing a tax on lower priority industries seeking dollars at the official exchange rate, Russ Dallen, head trader at Caracas Capital Markets, said in a research note. Or the government could simply create multiple “official” rates for different industries. Venezuela may create four different exchange rates to help the government deal with a drop in oil revenue.

“This complicated system, if implemented, would satisfy the requirements of the government of pretending not to have a formal devaluation of the exchange rate,” Dallen said.

Credit Suisse Group AG (NYSE ADR: CS) said in an Aug. 28 report that it expects the government to avoid devaluating its currency by selling dollar-denominated debt to the parallel market. In 2008, after an aggressive sale of dollar-denominated bonds, the administration was able to bring down the parallel rate to around 3 bolivars.

Ultimately, it’s Chavez – who opened the door to speculation in August by saying he would “restore balance” to the parallel rate – who will decide what to do about his country’s quandary. But he won’t be making a decision until later this month.

“Is there going to be an adjustment? I can’t respond to that right now,” Chavez said Sunday at the presidential palace in Caracas. “If any adjustment comes, it will be in September, towards the end of the month.”

But whatever Chavez decides to do, his remedy is likely to fall short, analysts say. That’s because the parallel rate is not the problem – it’s actually a symptom of flawed economic principles. The restrictive price-and-exchange-rate controls, government expansion, and political obtuseness that Chavez has made the cornerstones of his economic policy will continue to conspire against Venezuela until there is reform.

“We always said the situation was only tenable for the government if oil prices not only remained high, but also rose constantly. But that has not happened, and the fall in oil income is now clearly in evidence,” UCAB’s Ochoa told Inter Press Service News Agency. “That’s the first factor contributing to stagflation, to which are added price and exchange controls and restrictions on hard currency availability, which harm supply and investment, and thirdly, the policy of nationalization.”

Venezuela’s Crude Oil Slick

In the years leading up to the financial crisis, Chavez used PDVSA’s growing revenue to finance large social programs, as well as the nationalization of other industries.

Spending on social programs soared 340% from 2000-2005, according to the Center for Economic and Policy Research. It rose even higher as oil prices soared into 2008, boosting purchase orders and fueling a spending spree among even the poorest Venezuelans.

But since the financial crisis eviscerated commodities prices, Venezuela’s oil bounty has all but evaporated. Oil brought in $22.8 billion in the first six months of 2009. That’s less than half of the $52 billion it brought in during the first half of last year. For 2008 as a whole, oil generated about $90 billion in revenue for Venezuela.

Meanwhile, FONDEN – Venezuela’s development fund – has already committed all but $3 billion of the nearly $20 billion it had available at the end of January, as the government used most of the money in the first half of the year to sustain fiscal spending.

And while Venezuelan oil traded at an average of $53 a barrel in the second quarter, up from $40 a barrel in the first three months of 2009, that’s still a far cry from last year’s levels.

That means borrowing has had to rise to compensate for the decline in revenue.  Venezuela’s domestic debt jumped 44% during the first half of the year to $20.42 billion from $14 billion at the end of 2008.

“Public spending keeps rising and is financed by more public debt, which increases spending in a vicious circle, while the government defers or postpones workers’ demands, which is itself another sign of the approaching recession, although the government seeks to deny it,” economist Domingo Maza Zavala, a former head of the Central Bank told the IPS.

Calculations based on official figures suggest domestic and foreign debt repayments will total about $19.6 billion between the second half of this year and 2011, the Latin American Herald Tribune reported. Roughly $10 billion of that total will be due on foreign debt, with the remaining $9.6 billion destined for the domestic account. Total state debt is estimated at $50.3 billion.

What’s the government figures don’t include is the cost of compensating private companies that have been taken over or bought out under Chavez’s nationalizations and expropriations.

Chavez’s government earlier this year seized the assets of more than 70 foreign and domestic oil service companies after conflict erupted over nearly $14 billion in debt owed by PDVSA.

PDVSA demanded that service companies accept a 40% cut in their bills; when they refused, the Venezuelan government seized at least 12 drilling rigs, more than 30 oil terminals, and about 300 boats.

The demonstration was a pointed reminder of a 2007 incident, which is still playing out in the international courts. Two years ago, Venezuela forced six oil majors to hand over equity stakes of 60% or more to PDVSA. However, Exxon Mobil Corp. (NYSE: XOM) and Conoco Phillips (NYSE: COP) opted to walk away from their contracts rather than accept a minority role.

This conflict is still being disputed, and last year Exxon won a court order to freeze $12 billion in assets from PDVSA as compensation for its lost projects. Additionally, Chavez’s heavy-handed policy has cost the country untold billions worth of oil-related investments, as many oil majors now refuse to operate there

“There is the uncertain outlook over how the extensive nationalization pursued over the past 12 years will pan out,” Alvise Marino, an analyst at Ideaglobal, told The Wall Street Journal. “Based on the government’s unimpressive track record on the economic management front, we tend to take a less-than-optimistic view.”

The Colombia Conundrum

In addition to alienating foreign oil majors, Chavez has also sequestered Venezuela from many of its neighbors, especially Colombia. Chavez has ordered his country to prepare for an outright “rupture of relations” with Colombia after that country gave the United States permission to use its military bases.

The United States says access to the bases will help it fight drug trafficking, but Chavez has his own theory. He says American use of the bases could be used as a launch point for an invasion of his oil rich nation.

“Those seven military bases are a declaration of war,” Chavez said last week. “We must prepare for the rupture in relations with Colombia. There is no possibility of a return [to normal relations] with Colombia, an embrace.”

However, cutting off ties with Colombia poses yet another economic hurdle for the Venezuelan economy to overcome. Colombia provided about $6 billion in products to Venezuela in 2008, or about 15% of Venezuela’s total imports, according to Venezuela’s government statistics institute INE.

In fact, when Chavez closed the border for three days in 2006, there was shortage of food in Venezuela.

Chavez can turn to other South American countries, but his credit extends only so far.

“Nobody wants to sell to Venezuela if payment isn’t made in advance,” José Rozo, president of Fedecámaras Táchira, the region’s main business association, told the Latin American Herald Tribune

About 70% of trade activity in Venezuela depends on imports from Colombia, Rozo said, adding that the only country that had been willing to export on credit had been Colombia.

Without Colombia, Venezuela will have to settle for trade terms that heavily favor its partners.

For instance, Argentine President Cristina Fernandez de Kirchner made a visit to Venezuela last month, and signed no less than 22 accords. Virtually all of the deals were in Argentine’s favor, the Tribune reported.

“We’re going to drive a horse and cart through all the regulations if they want to do business with us,” an Argentine official told the paper prior to the signing of the deals. “Prompt payment. Simple procedures. Fewer controls. Less bureaucracy. No delays. Hard currency. I’ll tell you the rest when I’ve thought of them.”

That means if Venezuela wants to keep doing business with Argentina, it’s going to have to pay more.

And that will fuel inflation.

“The cost of purchasing in Argentina is higher, and that means that prices will be higher in Venezuela,” Abelardo Daza, an economics professor at Caracas-based IESA business school, told The Journal.

Source: Is Venezuela’s Stagflation the Beginning of the End for Chavez?

“Absolutely,” replied Argentina’s president. “We would never give up the peso-dollar link. It is too important to our economy. Without it foreign investors would leave and the economy would collapse.”

Five years later, Argentina cut the peso loose from the dollar. Foreign investors fled and the economy collapsed.

What lesson can you draw from this narrow set of facts? If you say, ‘politicians can’t be trusted,’ you are merely stating an obvious, universal truth, like ‘public toilets stink.’ But do they stink more on the pampas than, say, in London or New York? That is the question before us.

We begin by posing other leading questions: can investors depend on the money custodians north of the Rio Grande more than they could depend on those south of the Rio Plata? Why do people do things they oughtn’t do – because they are stupid or because they are just bad?

Today, Argentina is a mess. But it is an adulterated mess. The restaurants in Buenos Aires are still full. The beef is tasty. The women are pretty. The weather is nice. But so distrustful of Argentina’s public finances are investors that you could earn as much as 70% yield on a peso bond – the implied yield at today’s heavily discounted prices. If everything goes according to plan, you will get your money. But the 70% yield is a measure of how often things don’t go according to the plan. Investors here are used it. It is as if they got on a flight to Sao Paulo and ended up in Cordova or Brisbane. Or they turned on the hot water and got molasses.

It is these adulterations that make an investor’s lot so treacherous. Argentina’s main source of revenue is agriculture. Farmers are blessed by nature and cursed by politics. Nature gives them the richest, flattest, best-watered dirt in the world. With these advantages under their feet, a fair sun overhead, and a hugely expanding population around the world, agriculture on the pampas should be as easy as rolling tourists in Buenos Aires or selling stolen autos in the ghetto. Instead, the farmers go broke. Why? Math…and popular democracy. For every lonely hick on the pampas, there are 10 voters in the big city eager for other peoples’ money. That’s why farmers pay 40% export tax on their products to the feds in Buenos Aires and as much as 30% more to their local governments. By the time the tax collectors are finished with them, they are out of business.

But even at this level of public larceny, the feds are still faced with a crisis. The country doesn’t have the problems of North America or England. It was spared the credit crunch by its own incompetence and the collective misjudgment of lenders all over the world. Instead of giving credit to people with little of it, they lent to people with too much. The problem here is not the credit crunch, it is a cash crunch. Local economists say the trouble will begin in late June when the government won’t be able to pay salaries. Then, the country may enter another crisis – similar to what it went through in the period of 1999 through 2002. In anticipation, the ruling husband and wife team, the Kirchners, have pushed the elections forward 4 months, hoping to be re-elected before the voters catch on.

When a big guy in a dark alley says, “I don’t want to hurt you…” it is time to run. But the Argentine parliament offered a similar assurance to citizens in 2001. A law was passed guaranteeing that bank deposits would be protected.

A few days later, the bankers revealed that they lacked the funds necessary to keep up with depositors’ withdrawals. Meanwhile, the government needed to refinance its debt…but investors, growing wary, demanded higher and higher rates. In the end, depositors and lenders were hurt after all. The government froze bank accounts and defaulted on its foreign debt. By the time the accounts thawed out, the peso had been cut loose from the dollar and both lenders and savers had lost about two-thirds of their money.

There are times, we conclude, when despite the best of intentions, people do naughty things. Carlos Menem and Fernando De la Rua are probably no dumber or badder than Barack Obama and Gordon Brown. Both might have preferred not to freeze accounts or to devalue the peso. Likewise, Barack Obama and Gordon Brown might rather keep their currencies strong…reduce their fiscal deficits, honor their nations’ commitments at home and abroad, and join the community of saints. Maybe they will succeed in these things. But what trapped Menem and De La Rua was the relentless logic of debt and popular democracy. Mr. Menem fixed the peso by gluing it to the dollar. But there were other things that needed glue too. The urban voters, for example. They still needed their fixes of bread and circuses. And those cost money. Mr. De la Rua’s deficits ran to 5% of GDP. The weight of them finally came down on the gauchos’ necks like a guillotine. But 5% seems like a problem from another era. In France, the fiscal deficit for 2009 is expected to be over 8%. In Britain, it is nearly 10%. And in America, the feds’ excess spending will equal 13% of GDP.

As far as we know, Mr. Obama speaks no Spanish. Whatever mischief is forced upon him, it will have to be declared in English.

Enjoy your weekend,

Bill Bonner

Source: Cry All You Want

This from The Sovereign Society:

I found this chart online and thought it was such a good representation of what is going on that I just had to share it with you. (Thanks to the folks at http://frigginloon.com/ )

As I’ve written about before, this is really just the beginning of the flood of bad news we’re going to continually hear about over the next few months.

As you look back over this list, you’ll notice that none of the emerging market countries are on there just yet. And when they do appear, I’m afraid there will be more red X’s added to the list.

But now countries like Ukraine, Pakistan and Argentina are proving to be almost as vulnerable as Iceland. They borrowed money without real collateral to back those loans. And the industries responsible for making the payments are collapsing.

It seems as though another country is added to the growing list of nations on the verge of collapse almost daily.

Emerging Market Opportunities?

Having just accepted aid from the IMF, Hungary barely avoided sliding into national bankruptcy. And only a $15.9 billion IMF rescue package – bolstered by billions more from the European Union and the World Bank – prevented it from happening.

Analysts at Morgan Stanley estimate that capital flows to emerging economies could fall to $550 billion in 2009 from around $750 billion in 2007 and 2008. Such a sharp drop would hit economies that rely heavily on foreign finance: more than 80 developing countries are likely to run current-account deficits of more than 5% of GDP this year.

Countries do go bankrupt. Iceland is not the first (and will not be the last). Russia was declared bankrupt in 1998, Argentina in 2001 and Germany has a history of going more than once…

The problem is national bankruptcy would probably lead to massive inflation. This is demonstrated by the central bank of Iceland, which increased its prime rate by six points to 18 percent last week. Venezuela, where inflation is also high, is now offering 20 percent to stimulate interest in its government bonds.

And Argentina – having seized some US$29 Billion in private pension funds – has bond offerings yielding upwards of 30%! It’s worth noting; however, that the last time bond yields were this big in Argentina was in the aftermath of an epic bond default in 2001.

In the coming months, you’ll see more and more countries offering these huge double-digit bond yields. Most of these bonds will be coming from emerging markets that are already in trouble due to stifled capital flow.

Don’t do it!

I know your portfolio is probably looking pretty bad right now but this is not where you need to be investing. There’s just way too much risk in these emerging market bonds right now.

Not to mention that some more-developed countries are offering competitive bond yields as well. Sure they pale in comparison to 30% yields in Argentina, but at least you know you’ll get that money back.

On paper, 20-30% fixed-income returns look great. But I doubt you’ll ever see those returns make it to your bottom line.

Source: Don’t do it…

Everything fares well for Brazil.  Good news abounds and everyone is joyful… All is well?  No, not everything…. The inflationary specter has returned to frighten and preoccupy Lula, who up until recently had everything going well this year.

However, while everything was going well and the economy grew, so too did inflation, reaching 0.79% in May, the largest increase in the last 12 years.  So far this year retail inflation has reached 2.88% and 5.58% for the last 12 months.

And while it is true that inflation remains within the generous goal of two percentage points going either way, currently it is less than a percentage point from reaching the upper limit and is threatening to continue to rise.

Making matters worse, the inflation is making the poorest of the country its primary victim as food prices in May increased 1.95% (for an increase of 6.4% the last 12 months).

Is there a problem with an inflation level of 5.6%?  By comparison, Brazil is surely the envy of countries such as Venezuela and Ecuador.  However, the truth of the matter is that it is imperative to get levels such as these under control.  This is desirable not only because this level of inflation greatly affects the purchasing power of Brazilians (and it does), but also because it runs the risk of taking on a life of its own.  This in turn creates a vicious cycle, increasingly difficult to halt, for as food prices rise, the workers ask for higher wage increases (thus spiraling the situation out of control).

What will Brazil do to restrain the price increases?

In a similar situation, Argentina decided to limit its food exports (meats, wheat, corn, and the like) and the result was clearly different from that which was intended. Argentina now has an inflation problem far more serious than the one it had two years ago, only this time the situation is exacerbated by the fact that export revenues have been affected as well.  The higher inflation has stopped all investments in the economy, and Argentina was granted the investment rank of a “country not to be trusted”, due to the fact that they are now receiving less income from exporting meat than Uruguay does.

Perhaps it has not crossed Lula’s mind to limit food exports thanks to Argentina’s negative experience.

Brazil is one of the world’s largest food suppliers.  At a time of increased food production, it must now face a rise in food prices that is continuing to worsen.

Noting this situation, the Central Bank of Brazil has maintained a strong commitment to the stabilization of prices and it is clear from their demeanor that they are able to act independent of government constraints and that they are prepared to take whatever measures are necessary, including raising interest rates, to avoid runaway prices.

The Brazilian government’s Monetary Policy Committee (COPOM) Wednesday announced an interest rate hike of 50 points to 12.25%.

Brazil is showing how to combine long-term policies with measures directly related to the current situation… But how?

To clarify things: with this monetary policy, Brazil insures control of inflation using traditional methods. Since these efforts are directed at correcting the effect of rising prices, it fails to resolve the problems associated with the deterioration of the income level for the people.  Since taking office, Lula has been making plans to develop measures intended to address the needs of Brazil’s poor.  One of his plans is to increase the Family Scholarship Program’s funding to assist about 40 million Brazilians at a cost of around 11 billion reales (about U$S 6.75 billion) amounting to a 6% increase for each beneficiary (although Lula would like to see that rate a little bit higher).

Additionally, Lula has not only adopted a cautious position, but has also demonstrated sound judgment that has enabled him to take advantage of opportunities as they arise.  And this is important when one considers that increases in food prices are expected to continue for several more years.

As a result of this, Lula is creating programs to improve food production and the provision of necessary supplies (such as fertilizer).  Brazil is already contemplating measures to stimulate the growth of food production through its Program for Industrial Development (Programa de Desarrollo Industrial).

Brazil is doing well so far and that is why they are taking the current bad news so calmly, because the have confidence that the problems confronting them will be solved sensibly through strategic vision.

We will meet again tomorrow,

Horacio Pozzo

Buenos Aires, Argentina June 11, 2008

“And to think that I had to face a totally adverse situation… I wouldn’t have missed such an opportunity”… I can imagine what ex- presidents Raúl Alfonsín and Fernando De la Rúa are thinking to themselves about now, because although a substantial portion of what happens in a country depends on the capacity of governmental management, it cannot be denied that a good economic situation helps facilitate positive results.

Perhaps Lula would not have achieved all that he has so far, had he been elected president of Brazil in the 80’s.  The clearest example of this is demonstrated by the current management style of Alan García, the president of Peru… for there is no clear distinction in the way in which he governs from that of the past.  The fact is that although his style of governing has not changed very much, what have changed are the circumstances facing his administration.

With each passing day, the people are more and more aware of the fact that Argentina is failing to take advantage of a historic opportunity to leave the traditional cycles of growth and crisis (stop-and-go) which has plagued this country in the past. Argentina is being transformed into one of the few world-wide examples of a country that creates its own crisis at a time when the economic situation is quite favorable.

Even the most optimistic leaders could not have imagined circumstances as favorable as the ones Nestor Kirchner had during his presidential term.  Starting out during a period of such great international circumstances and with the opportunity to “fine tune” things, no one would have imagined that in just a few short years the situation would have come to where it is today.

The simple fact of the matter is that Argentina does not tend to move forward to establish solutions to the problems confronting it.  This Monday the government did manage to take a significant step, however it was one that advanced its problems even more.

On Monday, the Argentine president, Cristina Fernandez de Kirchner, let the public know what the government intends to do with the additional income generated by the agricultural tax retentions (ones that surpass 35%).  The strategy they are actually proposing is to hold their ground and not to reverse the decision to enforce the new taxes… Instead they are trying to justify those measures, by claiming to use them to provide greater social equality for all.

Cristina announced a “Program of Social Redistribution”.  With the money generated from the recent increase in taxes, the Argentine government intends to construct hospitals and to invest in housing and the country’s rural roads.  The execution of these public works will be realized in a decentralized way via the creation of agreements with the respective provinces and/or municipalities where these works will be performed … Could this be just another ploy to maintain political control?

It certainly looks that way. It seems that these measures are a way to maintain political control in the provinces.

In fact, these announcements do not solve many problems. In the instance of several of the provinces in Argentina, the problem lies not in the need to construct new hospitals, but rather in the current lack of funds providing basic expenses for the facilities that already exist. This is the real problem to be solved.  The need the provinces have for more public works is less important than the need for more income to cover basic operating expenses (such as consumable supplies and maintenance costs, for example).

Cristina is worried about the poor, and for that reason she needs more resources… And she does not always use them wisely … An example of this can be found on the website Misionlandia, which recently noted:  “to travel to Rome, President Cristina debuted a new presidential airplane leased from Aerolíneas Argentinas at a cost of U$S 400,000, paid for by the Secretary General of the Presidency”.

I think Cristina will have to immediately discard her fashion advisor, for how can anyone seriously consider someone’s concern for the plight of the poor who is flashing around in a French Hermès foulard? And I wonder who her fashion advisor is?  It seems that Cristina likes to dress well.  A few days ago the English newspaper “The Guardian” selected a group of  Heads of State for a photo gallery entitled  “Kings of Bling”: lovers of jewels and all the upscale brand names… and guess who is located there in the top ten ranking of the most fashionable and ostentatious presidents…

Of course Cristina offered her  point of view on the matter: “It is a good policy for me not to be masquerading about as a poor person”.  But sometimes her image is not in accordance with her words…

A recent magazine article discussing Monday’s speech noted that while Cristina is a harsh critic of the farmers, insisting they stop their blockades,  “the president was using jewels costing as much as a 4×4 truck.  She was wearing a Rolex worth about $20,000; on her left hand was an 18 carat ring of white and yellow gold with a brilliant solitaire, and on her right hand is a sapphire ring set in platinum and gold, each purchased from luxurious shops from abroad and valued at  $ 10,000 apiece… and a pair of hoop earrings valued at $10,000”.  A prestigious Italian newspaper, “Corriere della Sera”, presented the matter in a different way noting that Cristina “spent an hour shopping on Via Margutta” during the FAO summit in Rome and that she has bought jewelry in the prestigious Bvlgari’s jewelry store “Enigma” …  Clearly the government had to deny the report, but the number of details in this article regarding the shopping spree certainly gives one a reason to think.

Back to today’s article, here is my conclusion regarding the presidential speech on Monday: Argentina’s problems continue without being resolved (and worse: yesterday was the debut of the new price index methodology, one that is every bit as much as fraudulent and biased as the one it replaced)…  I have already told you about what can happen when problems are not confronted realistically by using solid measures to resolve them.    And what worries me more most is that the poor are going to be the ones affected the worst by the costs created by these mistaken political decisions.

We will meet again tomorrow,

Horacio Pozzo

Buenos Aires, Argentina June 5, 2008

In 2007, the strong appreciation of the Chilean peso had been the central preoccupation of the Chilean businessmen. In the last few months, active policies initiated by the Central Bank of Chile, coupled with a fall in the international price of copper and a strengthening in the worldwide value of the dollar have noticeably depreciated the value of the Chilean peso. In fact, the Chilean peso is the currency that depreciated the most against the dollar in the month of May.

This depreciation in the rate of exchange must have created a certain level of calm for Chilean businessmen. But while the exchange rate adjusted to the situation, other negative factors attacked the way in which businesses operate. For this reason, businessmen were unable to take full advantage of the improvement in the rate of exchange.

Inflation is perhaps having the worst effect on the Chilean economy at the present time, with a year-on-year rise of 8.3% for the month of April. Meanwhile, the Central Bank of Chile has as its goal an increase of only 3%, with a margin of 1% either direction. While the rate of inflation has been harming the Chilean economy, it has been partially offset by an improvement in the overall competitiveness of the economy.

The issue of inflation is causing Chilean monetary policy to move in a more restrictive direction for the next few months. This is why on May 8, during the last meeting of the Council of the Central Bank of Chile, it was discussed whether to maintain or raise the interest rate from its current level of 6.25%.

Even worse, the price of fuel has continued to rise and it is effecting the costs of production. The price of fuel is continuing to rise, and has already reached its highest level since 2001. Yesterday 120,000 trucks were lined up on a highway in a show of protest over this increase in the price of fuels. The government of Chile had injected $1 billion to create a Stabilization Fund for Fuels. However this has not persuaded the truck drivers to halt their protests.

Chilean businessmen are pessimistic, and with good cause, for they are finding themselves in a time of inflation while at the same time the Central Bank is insinuating that an increase in interest rates would adversely affect internal demand. And to make matters worse, Chile’s problems regarding power have been aggravated in the last few days by the cancellation of gas shipments from Argentina.

It is for that reason that business confidence finds itself at a historical low point in Chile. In fact, according to the Monthly Indicator of Business Confidence (IMCE), the perspective for commerce, construction, industry and mining fell to 53.4 points in May, the lowest level for that month since this registry was created. Logically, the most pessimistic area is the industrial sector for which indicator IMCE showed a value of 47.2.

Nevertheless, in spite of the general pessimism of businessmen, one can still find companies with good prospects for growth. Such is the case with the Empresa Nacional de Electricidad SA, (NYSE: EOC). During the first quarter of this year, ENDESA Chile reported earnings of $77,649 million (U$S 160 million) which represents a year-on-year variation of 44.5% (although principally due to increases that were not the result of operating costs).

Although the operating costs of ENDESA Chile have been affected by the low water levels and the high amount of fuel purchased in Chile, adequate commercial policies and the emergence of highly efficient stock portfolios have created a situation offsetting the effects of those factors somewhat. And all of this allows ENDESA Chile to be in a suitable position not only to face its next challenges, but also to transform them into opportunities for growth.

ENDESA is initiating diverse projects of investment that are mainly in Chile, Colombia and Peru. Also it has planned investment projects in Argentina.

In the middle of January of 2008, ENDESA Chile’s San Isidro II power station closed its combined cycle with a total power load of 353 MW. In 2009, once liquefied natural gas (LNG) is available in Chile, the plant will reach a total production level of 377 MW. The projected figures for the early portion of 2008 serve as an endorsement of Chile’s local electrical production ability. Another important contribution made by ENDESA to Chile’s power supply for the next few years is the installation, this past March, of the N°1 unit of the Taltal power station. This station has a capacity of producing 120 MW of power, using a diesel engine. Additionally, ENDESA is participating in the initiative of the Government to diversify the electrical grid through a project entitled GNL Quintero.

In January of this year, ENDESA signed a contract in Peru with Siemens Power Generation, to install a turbine that produces 183 MW of power in Santa Rosa plant. This project required an investment of approximately U$S 90 million. In Colombia, ENDESA is considering bidding for a public contract for energy and power programs for this year in that market by means of the development of a hydroelectric power station, capable of producing 400 MW, in Quimbo located upstream from the Betania Station. In Argentina, through its branches, Endesa Costanera S.A. and Hidroeléctrica El Chocón S.A., the company has realized an investment of U$S 160 million, that includes a U$S 42 million loan. This means ENDESA has a participation level of 21% of the thermoelectric societies of José de San Martín S.A. and Termoeléctrica Manuel Belgrano S.A. (with each of them producing combined cycles of 800 MW each).

Additionally, ENDESA Chile is a company that has a strong commitment regarding the environment through its development of projects using non-conventional renewable energies (ERNC) through its ENDESA branch Echo. It has a wind power-generating park named Canela that has been in commercial operation since December of 2007 that contributes 18.15 MW to the Central Interconnected System (SIC), Chile’s national energy grid. Also, ENDESA is committed to the acquisition of adjacent lands for the development of an immediate extension of around 60 additional MW to the park.

ENDESA Chile is a good company to bet on as an investment as a medium to long-term addition to one’s investment portfolio.

We will meet again tomorrow,

Horacio Pozzo

Editor’s Note: in Chile, businessmen seem to have been infected by the same mood as their Argentine colleagues. Although the reasons that affect the growth of both countries are almost the same, the origin of the problems and the search for solutions vary. The recommendation of the week. You can send your comments to me at: paola@latinforme.com

For the tale of the tape, the TSX Exchange gained 0.68%, while the TSX Gold Index rallied 1% and the TSX Venture Exchange, Canada’s largest junior exploration bourse, fell 0.19% with the declining issuers inching past the advancers by a 554 to 520 margin on robust volume of nearly 291 million shares traded.

Shares of Solex Resources got a boost after the company announced that its Princesa project in Peru hosts an inferred resource of 4.6 million tonnes running 90.88 grams silver per tonne, plus 1.66% lead and 1.69% zinc. Solex ended the day up C$0.05 at C$0.315.

Crystallex International got word from the Director General in the Administrative Office of Permits at the Ministry of the Environment and Natural Resources of Venezuela that their legal rebuttal has been denied. The news was already priced into the stock however as Crystallex ended the day up C$0.04 at C$0.84.

Antares Minerals rallied following news that the company cut 0.6% copper and 0.57 gram gold per tonne over 146 metres at the Rio Grande copper-gold project in northwestern Argentina. Antares ended the session up C$0.13 at C$3.88.

News that Stealth Ventures closed a C$22 million financing to fund work on its shale gas project helped propel its stock C$0.15 higher to close at C$0.98.

Brett Resources closed its deal with Kinross to earn 100% of the Hammond Reef gold project in Ontario. Brett issued 14 million shares and Kinross gets to keep a 2% net smelter royalty. Brett closed up C$0.06 at C$0.95, while Kinross added C$0.30 to close at C$20.12.

It was a lackluster start to June for the more speculative stocks but with the price of bullion once again showing signs of life it is only a matter of time before there is a feed down effect. We will see what Tuesday trading has in store.

Source: Resource Stock Roundup Tuesday, June 3, 2008

“Investors increase bets on US rate rise.”

Anticipating a rise in rates, rather than another cut, investors sold gold, bonds, and oil. The black goo lost $4 a barrel. Gold got slammed for a $23 loss, while yields on 10-year Treasury Notes rose over 4% (yields rise as prices fall).

Why would the Fed put rates up? Ah…that’s our story for today. It’s a story of numbskullery, tomfoolery, and chicanery…of vigilantes and blazing saddles…of war and forgetting. In short…it’s a typical financial tale, where nothing goes as hoped for…and everything goes as it should.

Let us back up.

Last year, we were writing about a ‘battle’ between inflation and deflation. The markets were deflating…but the feds were inflating. Who was going to win?

Actually, it was a mixed-up, woebegone war…with casualties all over the place and the average American household caught in the crossfire. The poor lumpenconsumer has been taking incoming from both sides for more than a year. His house sustained a direct hit from deflation. Then, his income got whacked by shrapnel from the dollar’s blowup.

Meanwhile, inflation blasts him with higher costs for just about everything – notably the essentials, fuel and food. What can he do but keep his head down?

And pity the poor guy who was lured out to a distant, new suburb by a big, new house with a big subprime mortgage! Now, he’s got to pay $4 a gallon to drive to work, while his house payment goes up and his house value goes down.

Naturally, the feds rushed to help the guy. His real problem was that he had too much credit…but didn’t stop them; they tried to give him more.

Still, when a bubble pops, it is almost impossible to pump it up again.

Henry Kissinger explains why in today’s International Herald Tribune :

“…the role of speculative capital has magnified. For speculative capital, nimbleness is the essential attribute. Rushing in when it sees and opportunity and heading for the exit at the first sign of trouble…”

Speculative capital is what the Feds create when they lend money below the inflation rate. It does not go out and invest in long term projects like steel mills. Instead, it looks for the hot, rising market…the one that will give it a quick payoff. The guy with the big house and the subprime mortgage was not really buying a house…he never paid for it. He was just speculating.

And now his speculation has gone bad…and all the Fed’s hot air goes into a new bubble. When the tech stock bubble popped, for example, the next big thing was a bubble in housing and housing-related debt. When the housing and subprime bubbles popped we guessed that the authorities would pump hard to try to reflate them…but that the Fed’s inflation would go into new bubbles – in commodities, oil, and gold. So far, so good. Oil slid up past $135. Gold shot up over $1,000. And food? Food prices are so high they’ve set off riots all over the world. The OECD says high food prices are here to stay. And farmers in Argentina are setting up roadblocks, again, to try to starve the capital into submission.

Getting back to oil…British truckers clogged up London earlier this week, demanding relief from high fuel taxes; truckers in Marseille shoved against riot police…again, complaining about the high cost of diesel fuel, which is running about $9 a gallon in France. We’re pleased to report than no mobs are forming to demand cheaper gold…but surely some bubble is in the yellow metal is bound to inflate sooner or later.

At the heart of the discontent is a very new, very disturbing, and very predictable fact: these new bubbles are not nearly as nice as the old ones.

*** The bubble in residential property made people feel good. They thought they were wealthy and thought they could ‘take out’ a little of that wealth and spend it. A bubble in oil is an entirely different matter. It makes people feel poorer every time they fill up their gas tank. And it forces them to cut back on spending rather than increase it.

Earlier this week we reported an historic downturn in Americans’ driving habits. For the first time since the ’40s, they’re seeing considerably less of the U.S.A. in their Chevrolets. This morning, comes this headline from Bloomberg:

“Sears posts net loss as consumers slow spending on clothing.”

They’re spending less on imports too – bringing the U.S. trade deficit to a 5-year low.

Remarkably, despite these huge victories for the forces of deflation, the U.S. economy is still growing and the stock market is not falling apart. The latest numbers from Washington tell us that GDP grew 0.9% in the last quarter, rather than the 0.6% previously reported. Knowing how the Labor Department suborns its numbers, however, we would want a good cross-examination before we believe them.

After the Fed intervened to save Bear Stearns, it looked for a while as if they had done the trick – as if they had succeeded in re-inflating the bubble in the financial industry. After the panic, the bank index rallied 22%. But now it’s given up almost all that gain. Banks are about 40% down from their high…amid talk of more pain and suffering in the industry. Wall Street, for example, said it had more layoffs coming later in the year.

Buenos Aires, Argentina May 29, 2008

I was speaking with a friend the other day regarding my concerns about the current situation between the Argentine government and the farmers. Ironically, his reply was “Well, at least the central bank holds nearly $50 billion in foreign reserves”. I immediately responded without any doubts: “That is true… I do not know what would have happened if those reserves were not there…”.

So what exactly is the relationship of the current conflict, between the government and the farmers, and policies governing the accumulation of foreign reserves in the Central Bank of Argentina (BCRA)? At first glance one might think there is “not much” but in fact there is a connection. Were it not for the present level of foreign reserves, the current dispute could have unleashed a major crisis.

The Argentine press certainly cannot complain about the government of Cristina Fernández de Kirchner for journalists now rarely have time to become bored since events are unfolding at an extraordinary pace. There is the unionist, who on the one hand is hoping for a negotiated settlement with the government, while on the other hand is striking in the fields. The current Minister of the Economy is an unknown, while controversial export duties imposed by the former, and better known, Minister remain in place.
And let us not forget there is currently an inflation rate that we are told is supposed to console us… indicating that everything is going to be alright… just wait… patiently… etc, etc, etc….

When Cristina took office expectations were high. The economic situation was going astray and many changes were expected. So what did happen? What is happening currently with the Argentine economy? For one thing, the problems surrounding inflation were never adequately addressed and that is why those problems have not only continued to plague Argentina but also seem to be spiraling out of control. We can look to the current situation with salary negotiations to see an example of what is happening. Many unions are demanding wage increases in excess of 30% while at the same time groups that had already negotiated raises of around 20% are now coming back demanding even greater increases, motivated by the current effects of this inflation – inflation that we are told is meant to console and not to concern us. (i.e. the teacher unions for the province of Buenos Aires received a 24% increase in wages three months ago, yet are currently demanding more.)

Many were hoping with a new government in place that public expenditures would be reduced. But to the contrary, they are currently growing at an expected annual rate of 40%. The country has also seen little improvement with the energy situation and when coupled with expected lowered temperatures this year one can expect adverse effects in its aggregate supply, a situation already hit by the current standoff with striking farmers and disincentives regarding investments in production.

Additionally, rising inflation is pressuring the government to increase the amount of subsidies given to transportation and utility companies (among others) since they are not allowed to raise their rates. All the while the government has tried to sweep all this under the carpet. However, the current situation has become so untenable that they cannot expect to hide these things anymore. So what is going to happen if the government decides to decrease those subsidies? How much longer can they be sustained to avoid price increases?

Six months into Cristina’s new administration, it does not seem that things have improved very much. I would even go on to say that in trying to resolve existing problems, she has created new ones that are far more serious that the ones she was trying to address in the first place. And the most pressing concern so far seems to be the current dispute over the increase in export duties imposed as a means of domestic taxation, to increase current revenues.

This increase in farm export taxes is the straw that broke the camel’s back for it has created a conflict of historic dimensions. This fact has been determined not only by the duration of the conflict but also by the level of support given to the farmers. As an example: last Sunday over 300,000 people attended a rally in Rosario Province in a show of support. That is unheard of in this country. This situation has not only frightened foreign investors, who were the first to reduce their interests in Argentina, but local ones are becoming concerned now as well.

Buenos Aires, Argentina May 26, 2008

Upon my arrival at home last Friday, my wife approached me with the following question: “What is the UNASUR?” Initially, I really did not know how to respond… I already have answers to some of her questions related to domestic issues such as why she cannot spend more money, why I have my clothing all messed up, who ate something, and others … but explaining the UNASUR really left me with no immediate answers at all.

To give you a little background, last Friday twelve South American countries formally ratified the Union of South American Nations Treaty (UNASUR), a regional integrative initiative going back informally to 2004. UNASUR hopes to strengthen Latin American and Caribbean unity by working together to create solutions to persistent regional problems while at the same time respecting the sovereign rights and territorial integrity of the individual member states. UNASUR hopes to achieve these goals through the development and implementation of policies addressing a diversity of issues such as those related to politics, economics, social and cultural issues, the environment, energy, infrastructure development and more. It is hoped that through addressing these concerns, solutions will also be found for the ongoing problems related to persistent poverty, social exclusion and inequality.

The members of UNASUR are Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Guyana, Paraguay, Perú, Surinam, Uruguay and Venezuela. To give you an idea of the importance of the region constituting this union: it includes 388 million citizens with a combined GDP of $ 1.9 billion, (3.5% of the world’s GDP).

UNASUR will be headquartered in Quito, Ecuador and consist of four main bodies: the Council of Heads of State and Government, the Council of Ministers of Foreign Affairs, the Council of Delegates, and the General Secretariat. It will also create a South American Parliament, seated in the city of Cochabamba, Bolivia.

One of those most delighted by the creation of this new union was Brazilian President Lula who pointed out that: “we shall move forward with innovative projects and will fully attain the goal of financial and energetic integration, as well as that of realizing the improvement of regional infrastructure, and the creation of a social cooperation agenda.” Lula, as always, has in mind ambitious ideas where of course, Brazil takes the lead in initiatives.

In reality, the creation of UNASUR has taken many by surprise as it has happened at a moment in history when the union of so many countries seems unimaginable.

Relating to this idea, we should be mindful that this union was created at a time when many Latin American countries have reached a powerful level of macroeconomic and institutional consolidation; achieving international recognition as having gained the much desired investment grade for many of its countries.

The establishment of regional blocks is more viable now with the consolidation of the economy and institutions within these countries, coupled with a long-term vision. The regional blocks of the past have not reached significant achievements in the long run due to difficulties within their individual countries, recurrent crisis and political instability. Mercosur serves as a prime example of these kinds of problems.

In the instance of UNASUR, there is a political and ideological fragmentation among many of the signatory countries. There are countries with serious internal problems such as Bolivia. Venezuela and Argentina are plagued with internal issues as well, but to a lesser extent. There are also member state conflicts such as those between Colombia, Ecuador and Venezuela. Additionally, there are ideological divisions between several countries that make it very difficult to imagine how those countries could go forward with the successful coordination of policies.

UNASUR’s successful unification of regional forces having benefits realized by all member states will depend in part on the influential leadership of Brazil coupled with the lessening of individual differences between countries.

This brings us to the question: what benefits could UNASUR bring investors in the region? I think that there are no short-term benefits. However, if UNASUR is able to successfully establish itself, it can then contribute to the development of the regional financial market (one of its main stated goals) creating one with stronger depth and liquidity than other financial markets of the region. More importantly, UNASUR can contribute to the strengthening of the regional economies, underpinning their growth and development which will benefit the investor who will then find less risk and more profitability in their investments in the region.

The UNASUR has just been born. It will be necessary to give it time to grow and develop. We hope that the countries comprising this new group allow this to happen.

We will meet again tomorrow,

Horacio Pozzo

Editor’s Note: A new community in South America is born with a variety of diverse and complex objectives spanning cultural, social and economic realms… another aim is the social inclusion, the civic participation, the strengthening of democracy for all… Horacio’s wife is asking questions and Horacio finds he does not know how to respond. If you want to know, keep on reading… Enjoy, and send your comments to the editor here: paola@latinforme.com