Peru General Observations

Crossroads / Corner of the Dead

Peru MapPeru has been an important South American crossroads for at least 600 years. The province of Ayacucho along with its capital namesake is a focal point of the country with a strategic trading location between Lima (the nation’s capital & largest city with ~1/3 of Peru’s population) an another historically integral hub, Cuzco. To understand just how long the area has been important to this continent, the oldest known inhabited cave in South America, Pikimachay1, is located here. The cave holds extensive signs of habitation including harvested Giant Sloth bones dated to ~20,000 BC. Appropriately, Ayacucho translates into ‘corner of the dead’. This is the land where Inca predecessors, the Wari, fell after creating intricate aqueducts, roads, and such wondrous achievements as plumbing from clay pipes. The Incas with their conservatorship of the Wari’s accomplishments together with the dual exploitation of naturally freeze dried potatoes and their masterful accounting system also fell here.

The Spanish with their well organized military and wealth extracting forces saw their colonization of all South American fall here. This foreboding history is relevant to Peru’s present challenges. Major trans-continental highways are being built from Brazil through Peru to the coast. Already two major natural gas lines, one to Lima and one to Pisco (pronounced peas-co, located 130 miles south of Lima), have been brought through the region from Peru’s Amazon jungle to the northeast. Another, being built by the Hunt Brothers (Texas), will also proceed through this region and on to Pisco. These lines are providing cheap fuel to stimulate all areas of the economy.

Peru Gasline Map

Coastal cities between Lima and the southern border with Chile are well positioned as the continent’s premier air and water ports for exporting resources to meet the demand of rising eastern wealth. It should be noted that these ports also give the Chinese access to something equally as important as copper, zinc and agricultural products: ~390 million South American consumers. It is this interplay of hard and soft resources through a dance that spans the eastern and western hemispheres that is defining Peru.

Equity / Equality

An argument can be made that Peru’s modern economic period began in 1969 with the passing of its Agrarian Reform Law2. At that time the duly elected president had just been overthrown by a military coup. It was decreed that the vast majority of private land be ‘contributed’ to community agricultural organizations. The officials put in control were neither good stewards of resources nor blessed with business acumen. So as the bureaucratic inspired inefficiencies required additional funding, finances became stressed. Eventually it became impossible to make payments on bank loans. The banks began foreclosure proceedings. In response, the government decreed that the vast majority of these loans would be forgiven. Overnight, Peru’s agricultural lending sources were vaporized.

Understandably, considering what had transpired, additional lending to the community agricultural organizations all but halted. Peruvian agriculture production declined (chart, at left). Next, newly out of work farmers found their way to ‘reeducation’ at the universities. One of the oldest universities in the western hemisphere is located in Ayacucho. Even today, a square there hosts a statue of Karl Marx. This evidences the control that Chinese communists exerted over this and many other institutions of higher learning. Desperate farmers seeking answers to their plight slowly began to embrace what was being taught – even in the face of the immediately preceding failure of the community agricultural organizations. In 1980 the Sendero Luminoso 3 began its horrific reign of terror on the country. The movement, which translates to Shining Path, was named for references found in Karl Marx’s writings and was birthed at the universities. But this is where the ‘corner of the dead’ spawned something yet again unexpected. The communist led revolution was met by a peasant counterrevolution. What ensued is beyond description. A common story would have a community invaded by terrorists demanding provisions. If the mayor would not comply, the terrorists would then commence brutal executions, usually beginning with the mayor’s family. At some point the provisions would be turned over. The following day, upon learning of this ‘compliance’, the government would slaughter many of the remaining peasants due to suspicions of loyalty. What a terrible mess.

Peru Index of Total Per Capita Food Production

The reason for a review of this history is related to the pillar of investing: Integrity (doing the right thing even when nobody’s looking). When Peruvians used to greet each other in a town or on the roads, rather than say hello, they had three sayings; do good, don’t lie, work hard. By the time the peasants and the government ended the terrorist reign in 1992, these greetings had vanished. It is likely that the extreme distrust created by the conflict had finished them off – which coincided with the demise of general integrity. While many in the campo (rural areas) understand the meaning of equity investing, it generally does not exist. Without assuming integrity, it can not exist. Thus much of Peru’s rural economy and cottage industry is financed only through lending. This is not an optimal capital structure especially when one considers the crucial, and continued, role that Peru is likely to play as a transit point for much of South America. It takes equity to reduce stresses on early business formation so that cash flows can be grown until they can support and justify loans. So, in short, Peru is a country with limited access to the fundamental building blocks of business; integrity and its son, equity. While the communists did not succeed in taking over the country, they did succeed at diminishing Peru’s sovereignty by destroying one path for peasants to advance into the middle class. However, since the terrorism ended it should be noted that the proportion of undernourished has fallen from 28% at the end of the revolution to roughly 13% now4. Additionally, there has been a baby boom which has led to the average age moving from 71 to 59 years5.

Lending
Monthly Meeting of a FINCA BankIn 1993, the year after the remaining terrorist leaders were either slaughtered or imprisoned, the FINCA6 organization was formed. FINCA seeks to leverage investment and community together in an effort to thrust families into the middle class so that the economy and country have a shot at stability. When the majority of a society is involved in work that is productive and meaningful, really terrible periods are less likely to occur. Conversely, when basic comforts such as water & electricity, jobs, or safety are reduced discontent is not usually far behind.

Medium Scale FarmSince there was, and remains, little in the way of equity capital an idea was hatched to cobble together multiple burgeoning micro businesses and ordain their collective cash flows as collateral for small loans. Roughly 270 banks have been formed by FINCA. The loans are made for 16 week cycles after which they become payable in full. It has worked well across Peru’s interior. Default rates are very low and each bank lends to such diverse areas as engine repair, animal farming, and various agricultural operations. Each bank member eventually takes a turn at running the organization. This rotation of leadership reduces corruption as well as assists members in understanding how their bank works. Monthly business training is required for each member as well as their children aged 7 through 11. The program is positioned to be aggressively grown and is a good step towards broader capital formation.

Price Pressures / Invasions

A fairly accurate way to keep tabs on a country’s inflationary pressures is by tracking its real estate and art markets. In Peru it is stunning to find urban housing and art (mostly beautiful woven blankets and rugs) prices in some areas as high as those in the USA. While this is a sign of serious pricing pressures from large scale ‘crossroads’ projects, inflation is also being generated by an often overlooked source – NGOs (Non-Governmental Organizations7). Put simply NGOs are generally non-religious European and USA entities who say they are engaging in works to benefit the poorest of the poor.

Peruvian Hand Woven Rug

Interestingly a very large number of their Peruvian efforts appear to be highly correlated to areas of current and perceived development. While the data is circumstantial at this point, the apparent front running of large crossroads projects for profit is an interesting trend to follow – or a terrific thesis paper. Another effect of rising real estate and housing prices has been the crowding out of peasants from land ownership in reasonable proximity to cities. The net effect has been startling. ‘Invasions’ are the organized occupation and appropriation of governmental, community, or private lands. Apparently after some arbitrary time the government will allow invaders to take possession if the rightful property owner does not have the influence or wherewithal to force them out. This is one of the greatest impediments to the development of small and mid scale commerce in Peru – exceedingly weak property rights.

An Invasion Neighborhood

Silver Lining

Mounting inflationary pressures, limited risk capital, and nebulous property rights are causing difficulty for small and mid sized business formation as well as societal divisions in the interior. Left unaddressed, Peru is likely to struggle with continued conflict and a wholesale export of profits by multinational organizations. However, there is good opportunity for broad coastal economic expansion with a completion of the transcontinental highways that would open up the Brazilian interior to Peru’s Pacific ports. A large portion of the goods that are moved to Brazilian seaports for export may be more economically transited (time savings as well as transit costs) via Peru. The potential is truly massive as Brazil currently exports roughly six times that of Peru.8 Another opportunity lies in the abundant and cheap natural gas available in the country. According to the Peruvian government citizenry have seen a 30% decrease in electricity costs and manufacturing businesses see average savings at 50% of production costs due to the adoption of natural gas.9 In addition, the nation has encouraged the conversion of vehicles to natural gas. The most recent statistics indicate that the annual savings is more than US$500M, or 60% per tank.10 These savings will somewhat offset other inflationary pressures and assist the working class in making ends meet. This also implies that more of the nation’s
income will stay in the local economy rather than be exported in return for petroleum. Finally, the costal region south of Lima is seeing steady arrivals of manufacturing establishments. Located in one of the world’s most arid deserts manufacturing costs are low. Incredibly, manufacturing labor is cheaper in Peru than China.11 When this is added to cheap fuel and an environment where facilities and goods last longer, one begins to wonder when China or Brazil will decide to locate manufacturing capacity here. While it will take time for this to develop, Peru should have a future as a large scale value-add manufacturing crossroads for the Americas.

Peru

ADDITIONAL REFERENCE

  1. Agrarian Reform Law: http://www.nationsencyclopedia.com/Americas/Peru-AGRICULTURE.html
  2. Sendero Luminoso: http://www.cfr.org/publication/9276/
  3. FINCA Peru: http://www.fincaperu.net/cms/index.php/es/
  4. Non-Governmental Organizations: http://www.ngo.org/
  5. Labor Costs: http://www.worldsalaries.org

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