The Ottoman Empire and Argentina. History shows, beyond any shadow of a doubt, that the collapse of any empire, nation, or economic system is caused by its slow, steady, and irreversible decay. Two main forces cause the implosion.
The first one is internal. The increase in the power of the bureaucracy and selected power groups stifles the modernization of a country and restrains the reinvigorating entrepreneurial forces that accompany any market system (please see Political Systems on our website www.peterdag.com under Understanding the Markets for more details).
Education and investments inevitably fail to keep abreast of the requirements of a changing world. The outcome is that the country finds it extremely difficult to compete against more efficient economic systems.
This is the time when the second force causing the implosion gives the final blow. Borrowing to modernize the country is the concluding act in the collapse. But borrowing is no solution because loans have to be serviced. Furthermore, the more corrupt and inefficient is the system, the higher is the risk premium being charged by the lender. This raises the interest rate cost to prohibitive levels. The outcome can only be the inevitable bankruptcy.
The Ottoman Empire in the late 1800s, the Asian Tigers and Russia in 1997-1998, and Argentina in 2001-2002 followed this exact script.
The Ottoman Empire had to borrow to improve a decaying system, especially when compared to a rapidly industrializing Europe. The money was supposed to improve the industrial sector. But the education system and infrastructures were not in gear with the changing times because of the unique and more classical requirements of the Arab society.
The Ottoman Empire squandered the money and the Europeans invaded the Empire to get their money back. The lenders forced its capitulation and asserted the European colonialism of the area.
In 1997 the Asian Tigers pegged their currency to the US dollar. This move was intended to convince the industrial world that they had a competitive system, not only cheap labor. In fact they thought it was so efficient that they were not afraid to fix their currency to that of the most powerful and wealthy economic system of the world: the US.
Money flowed into these countries and was squandered as it happened 200 years earlier by the Ottomans. Eventually, when it was clear that they could not repay the loans, the system collapsed, and their currencies devalued sharply.
Argentina followed the exact same plot. An inefficiently bureaucratic and corrupt system convinced itself it was in the same league as the US. They pegged their currency to the US dollar as a solution to their problems.
Investors and lenders believed in the good intentions of the politicians who had no plan or political muscle to change a chronically obsolete economic system. Money flowed into this black hole and was lost forever.
As it happened before to the Ottoman Empire, the Asian Tigers, and Russia, loans could not be repaid and the country was forced into bankruptcy. They had to de-link their currency from the US dollar and sharply devalue the peso.
The lesson is that we need to beware of countries pegging their currencies to those of more efficient and competitive economic areas. Pegging currencies is not the solution to internal inefficiencies. The groups in power would rather go down with the system than change and lose control over the country. Besides, if the system is efficient, supported by modern infrastructures, there is no need for tying its currency to any country.
Europe is the latest of these experiments. Can Greece have the same currency as Germany and survive? The fact that the euro is weak does not surprise me, as you well know. But this will be the subject of a future commentary about regional currencies.
(This
Observations appeared in the issue of 2/11/02 of
The Peter Dag Portfolio)
George Dagnino, PhD
Editor,
The Peter Dag Portfolio. Since 1977
2009 Market Timer of the Year by
Timer Digest
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