How safe is your money?

  • Lessons from the ‘Corralito’
  • The ‘Mega Debt-Swap’
  • To the pots and pans!
  • Deposit guarantees can fall short

During the short time I’ve lived in Australia, I have heard people talk about crises — mostly happening in Europe, China, and the US.

And the discussions always seem very detached, as if crisis is a very distant, hypothetical situation. The fact is, it has been so long since Australia had a recession — 25 years — that many people here have never lived through one…or don’t remember one.

This lack of hardship has understandably led the majority to believe that money in the bank is safe. And will always be available. You may feel the same way.

But things can change quickly.

In 2008, after a mild bank run scare, the Australian government established the deposit guarantee.

The government is currently guaranteeing deposits up to $250,000 per approved institution. However, there are fears that the government may not be able to honour its promise.

The deposit guarantee (as the legislation currently stands) is limited to $20 billion per institution. Yet the big four banks each have deposits in the hundreds of billions of dollars.

You can see there’s no way that $20 billion is anywhere near enough to protect all deposits. And, more to the point of what I want to share with you today, a bank guarantee does not assure that you will be able to access your money during a deposit freeze.

Can a deposit freeze happen in Australia?

While this may sound like an unlikely scenario to you today, anything can happen…even if it is a low odds event at this stage.

The next financial global crisis, coupled with a loss of confidence in financial institutions, could see a bank run here in Australia. Depending on the severity of the run and bank assurances, the government may decide to up the deposit guarantee. And if that measure fails, it is likely that they may impose a deposit freeze.

So what does a deposit freeze look like?

It is with this in mind that I share my family’s experience with you, in the hopes that it will help you prepare for a worst case scenario.

But before I get to that. Let’s have a quick look at the markets.

Markets

Markets in the US continued to rebound on Friday. The Dow Jones closed up 0.11%, while the NASDAQ gained 0.45%, and the S&P 500 rose 0.19%.

European markets were in the black as well. The FTSE 100 added 1.13%, while the DAX rose 0.99%. And the French CAC 40 clawed back another 0.86% of the heavy losses suffered in the days following the Brexit decision.

Over in our corner of the world, the Nikkei 225 is up 0.60% at time of writing. The Shanghai Composite is up 1.77%. And the ASX 200 is up 0.25%.

The Aussie dollar is bang on 75 US cents.

And in commodities, West Texas Crude is trading at US$48.94 per barrel, and gold is at US$1345.80 per ounce.

Now where were we? Oh, yes, a nationwide deposit freeze.

Lessons from the ‘Corralito’

It´s six days before Christmas.

Your life savings are secured by the bank. And by secured I mean locked in there. You entrusted the bank with everything you worked for throughout your life. And that trust is broken.

During the holiday season you’d planned to see friends and family, travel, buy gifts, and eat well. Now, enjoying Christmas is the last thing on your mind. You cannot access your money for any of that. YOUR money.

Even worse, you have no idea when — if ever — you might be able to get to your life savings again. And no idea how much will be left when you do.

To top it off, the value of the Aussie dollar is decreasing by the day. Even if you do get all your money back…eventually…it will be worth a lot less than it is right now.

And you are not alone. The whole country is in the same situation.

OK. This hasn’t happened in Australia. But we know the possibility keeps many subscribers awake at night. I know it’s cost me some sleep.

In Australia, debt is outstripping deposits. The Australian government has guaranteed cash deposits up to AU$250,000. But as fears of an economic crisis grow, how do you protect your life savings?

I’m not just throwing this at you to stir your angst. I’m telling you this because the scenario I describe above actually did happen. And members of my family were swept up in the fallout.

You see, in 2001 Argentina was immersed in the ‘corralito’. The word comes from ‘corral’, and refers to the pen that keeps farm animals in.

The ‘corralito’ is a deposit freeze.

Argentinean banks were keeping bank deposits locked inside the bank to prevent a bank run.

Nobody could withdraw their money. 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.

There have been many deposit freezes in history, but none as savage as the Argentinean one.

How did they get there?

A bit of background

The crisis had been brewing for a while. In fact, since 1989.

The country had been suffering from hyper-inflation. In 1989, the inflation rate was 3079.8%. That’s right. It’s not a typo, 3079.5%!

If you have ever experienced hyper-inflation, you know it’s horrific.

It gives you a sense of instability, fear and desperation.

Prices go up hourly. If you buy a coffee in the morning, the price has already leapt up by the afternoon.

When people received their salaries at the beginning of the month, they would rush to the banks. To exchange their money into US dollars.

It was the only way to keep the value of your salary until your next pay check. But this was a vicious circle that only fed inflation even more.

Traders refused to sell their products. Because if they sell, they lose money. Money received from sales doesn’t cover the cost to replenish stock. Basic products are scarce and traders start using them as reserves.

Hyper-inflation ate up salaries and caused riots and lootings.

It also precipitated presidential elections. President Raul Alfonsin quit 5 months before his term was over. In July 1989, Carlos Menem took the presidency.

Menem reorganized and deregulated the economy. He opened up foreign trade and movement of capital.

But his first challenge was to tackle hyperinflation. In 1990, inflation was still soaring at 2314%.

To create stability, Argentina´s new economic minister, Domingo Cavallo, announced the convertibility plan.

With the convertibility plan, the country let go of its traditional currency, the austral. The official currency became the Argentinean peso. And the value of the peso was pegged to the US dollar.

Their values became interchangeable. That is, AR$1 = US$1.

Most companies and workers received their income in pesos. But held accounts in US dollars.

They could choose to pay their debts in either currency. During that period, most private citizens chose to contract debt in dollars.

Even the banks operated with dollar accounts. There had never before been so many US dollars at the disposal of the public.

A foreign currency had become an intrinsic part of the Argentinean financial system.

Although this succeeded in ending hyperinflation, keeping the peso in parity with the dollar made Argentinean exports more expensive. This logically decreased the amount of exports. Imports, on the other hand, became cheaper. The country’s trade balance became negative.

The country was not living off what it produced. And foreign debt increased.

Menem privatized many of the state run companies to foreign entities. He wanted to transform the state from ‘large and weak’ to ‘small and strong’. Public services such as telephone, rail, airline companies, gas, and oil became foreign owned.

To maintain the currency in line with the dollar, the country was sold off bit by bit.

The size of the government shrunk, but foreign debt kept growing. And to keep the convertibility plan, Argentina had to keep on borrowing.

The plan should have only been a temporary solution, but it became a permanent one. The government should have transitioned to a fluctuating peso against the dollar. But they didn’t.

By the time Menem left the presidency in 1999, the peso had been pegged to the US dollar for 8 years.

It had achieved its goal — creating stability and lowering inflation. In fact, inflation remained low or negative for most of the 1990s.

But 36% of the population was now under the poverty line.

How could there be such hunger and unemployment in a country that was considered the world’s granary?

The privatizations increased unemployment. It went from the traditional 5% to 18%.

External factors also affected Argentina. The Asian crisis, the devaluation of the Russian ruble and the Brazilian real pressured the Argentinean peso.

In the ten years Menem had been president, external debt grew from US$65 billion to US$146 billion. A 124% increase!

The country had to keep on borrowing to maintain the convertibility plan.

And they were paying a lot of interest for that debt. Between 1993 and 2001, the amount of interest paid by the state went from 1.3% to 5.3% of GDP.

In 1999, Fernando de la Rua replaced Menem as president. He inherited a ticking time bomb.

It was clear that the Argentinean peso was overvalued. And he needed to take measures.

He had three options.

He could make the US dollar the country’s official currency. But Carlos Menem had already tried this plan and failed. And it gave the impression that the government had no confidence in the peso.

Another option was to devalue the Argentinean peso to its real value.

Or he could maintain the convertibility plan.

De la Rua chose the latter.

After having lived through hyper-inflation, Argentineans didn’t want to leave convertibility. They saw it as a remedy against inflation.

So they kept borrowing to sustain the plan. But the borrowing came with strings attached. In exchange for the money, the IMF imposed severe conditions that increased unemployment.

And fears that Argentina would default from its debt kept rising.

And after two economic ministers resigned in a row, he reinforced his decision by adding the ‘father of convertibility’ to his cabinet.

Domingo Cavallo was member of a different political party – with which he had run for president and lost in the 1999 elections – and had been the previous president’s economic minister. But it didn’t matter. He became De la Rua’s third economic minister in March 2001.

But the election of Cavallo did not quiet down the fears of a crisis. Most people in fact, were still expecting one. And they took measures to protect their income.

But Argentineans made one fatal mistake.

They thought their deposits were safe in the banks.

The ‘Mega Debt-Swap’

Once Cavallo took charge of the economy, he realised the biggest problem was lack of time.

Argentina’s debt was short term. He needed more time to repay it.

With that in mind, Cavallo announced the ‘Megacanje’ (Mega Debt-Swap).

Today, the Argentinian justice is still investigating the Megacanje as a possible fraud. And many of the creators are awaiting trial — including Federico Sturzenegger, the current Argentinian Central Bank Director.

You won’t be surprised that a banker came up with the plan. David Mulford was the ex-US treasury undersecretary and a senior official at Credit Suisse.

The Megacanje’s premise was simple: exchange time for higher interests.

Mulford and Cavallo picked seven banks — among them, sure enough, was Credit Suisse — with which to exchange government securities.

The term of the debt repayment period was extended until 2005. But as part of the deal, interest increased from 6% to 15%.

The only thing it accomplished was to defer the problem and increase the debt. After the Megacanje, all the government could do was to pay interest on the debt — there was no money left over for any economic policy.

But the banks — and Mulford — got a hefty commission for exchanging securities they already held…to themselves!

It was soon clear that the Megacanje was not the solution. And that things were only going to get worse.

Unemployment stayed at record highs, and reserves kept falling. Fears of an Argentinian default increased. And by the end of November there was a run on the banks.

At the same time, the IMF announced they would block a new loan as the country had not achieved its goals.

With no new money coming in, the economy paralysed.

And the government got nervous.

So on 3 December 2001, following government’s orders, the banks closed their doors.

The measure became known as the ‘corralito’. The government penned in the money that was already in the banks. They restricted withdrawals to 250 pesos per week and prohibited transfers abroad.

People could not access their money.

Just like that, Argentinians lost control of their savings. And they had no idea when they would be able to get them back.

And as Christmas and vacation plans fell through, so did the confidence in Argentinian institutions.

On 2 December, just before the government announced the measure, speculation was rampant. This later led to many insider-trading accusations.

You see, there is a 200km-wide river that divides Argentina with neighbouring Uruguay. The night before the corralito was announced, an abnormal amount of luxury boats crossed the river. Many are believed to have transported physical money offshore.

The corralito choked the already brittle economy. It paralysed the country and the banking system.

People were desperate to get their money, and faced large queues to withdraw the weekly sums. Tensions ran high as people blamed the banks.

The measure affected small savers. The middle class, in particular, felt that the corralito was an attack against them.

And this time, the government had gone too far.

To the pots and pans!

Tired of mistreatment, the people rebelled.

The 19 December protest started as a peaceful and spontaneous movement. It was an expression of disappointment against the government’s economic policies.

Thousands of people started banging pots and pans from inside their houses. The deafening noise could be heard all over the capital. This action, known as ‘cacerolazo’, became a symbol of protest.

Many people then took to the streets with their pots and pans. There were pensioners and children in the crowd. All they wanted was their money back — and for the government to leave. They surrounded the presidential house chanting, ‘Everyone go away!’

Cavallo, the economic minister, resigned — but protests did not quiet down.

The police were worried that the crowds would try to enter the presidential house. So they threw tear gas. And the streets turned into a battlefield.

After two days of protests, President De la Rua resigned. He fled the presidential house from the roof in a helicopter, taunted by a booing crowd.

He abandoned the convertibility plan 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. It reached AR$3.90 pesos to the US dollar — almost four times lower than its original value.

At this point, you need to bear in mind that people were still not able to access their money. The ‘corralito’ was still in place. They could only watch as their savings diminished with every devaluation against the dollar.

It was clear that there was no possibility of recovering their money in its original value from the bank.

Deposits were finally freed in December 2002 — the corralito had lasted an entire year.

But the savings were not worth the same.

The biggest losers were small savers and pensioners. Many savers took the government to court. It would take them five years to get a favourable resolution.

The other big losers were those with fixed term deposits in dollars. The government offered them two alternatives to recoup their money.

The first was that they could exchange the dollar savings for treasury government bonds — payable in 10 years!

The second was to receive government bonds in pesos (at the rate of 1.40), payable in five years.

My grandfather was among the many people with a dollar fixed term deposit.

Originally from Spain, he was drafted at 17 to fight in the Spanish Civil War. Having suffered the war and its aftermath, he was determined to never struggle again. In the 1930s he emigrated to Argentina in search of a better life.

He worked hard — sometimes holding two to three jobs at a time.

And he was a rigorous saver. Every week, he would deposit part of his salary into the bank.

My grandfather chose the first option. He exchanged his dollar savings for treasury government bonds payable in 10 years.

But unfortunately, he passed away before the time was up. And his descendants can have no claim to the bonds.

Just like that, most of his life’s work vanished. Talk about generational wealth loss!

Banks failed in keeping safe the money people had entrusted them with. That’s why Argentinians have become pros at keeping money outside the banks. They have around US$183 billion outside the system — equivalent to 38% of the GDP.

They distribute their wealth in many ways to cut risk.

They hold money in bank deposit boxes or in private safety boxes.

They invest in stocks or bonds.

And they open US dollar accounts outside of the country.

Argentinians have learned the hard way that having money in the bank does not ensure its safety.

Deposit guarantees can fall short

Now, while Australia’s deposit guarantee does offer some benefits, it does not mean that you will be able to access your money during a deposit freeze. Or that a currency devaluation, while it’s frozen, will not affect it. 

Does this mean you should take all of your money out of the bank? No. At least not yet. But you should be aware of the warning signs to look out for. Signs that indicate a deposit freeze may be in the works.

In Argentina’s case there were several warning signs flashing well before the corralito.

The trade net balance had reduced. That is, imports surpassed exports due to an overly strong currency. And this lower net balance decreased the country’s reserves.

Another sign was the increased amount of debt levels relative to GDP. Argentina became debt-dependent to maintain an unsustainable model of growth. And the system crumbled when they could not take on any more debt to sustain it.

Argentina was living beyond their means. Eventually, that always catches up with everyone.

This is precisely what Vern Gowdie, editor of The Gowdie Letter, warns you about in his book, The End of Australia: The Real Story Behind Australia’s Economic Collapse and What You Can do to Survive It.

If you’re worried about the mess central bankers and government officials are making of our financial markets, you can find out more about how to protect your own wealth here.

Regards,

Selva Freigedo,
Analyst, The Gowdie Letter