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The Silly Ideas of the South

October 27, 2008 |
All crises that begin in the rich countries spread south; those that originate in the south rarely travel north.
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Over the past few weeks, some silly ideas have circulated on the impact of the financial crisis on Latin America. The most dangerous was that Latin America would be largely impervious to a debacle that was, as Brazilian President Luiz Inácio Lula da Silva imprudently phrased it, "Bush's crisis." Leaders ranging from Mexico's Felipe Calderón on the center-right to Fidel Castro and Hugo Chávez on the extreme left all claimed, for different reasons, that orthodox macroeconomic policies, recent growth, solid banking systems, the high price of commodities (oil, soybeans, copper, iron, coal) and tighter market regulation and supervision would help spare the Latin economies from the woes of their partners across the Rio Grande, the Atlantic and the Pacific. Or, in their more excessive moments, Castro, Chávez and a few others (on occasion, Argentina's Cristina Fernández de Kirchner) gloated over the demise (finally) of the capitalist system, from which socialist countries like theirs would emerge in better shape than others.

Well, the Brazilian real has dropped 30 percent from its August high and the São Paulo stock exchange has fallen 45 percent since the end of June. The Mexican peso has fallen 30 percent against the dollar since mid-September, and the local stock exchange has collapsed. Commodity prices, which through direct ownership (Mexico, Venezuela, Ecuador, Colombia, Chile) or taxation (Argentina, Bolivia) provide huge shares of government revenues, have dropped sharply. Growth forecasts for the last quarter of 2008, and mainly for next year, have been cut dramatically. So much for the idea of Latin immunity from contagion.

It was always naive, even deceitful, for these experts and rulers to maintain that the region would be cushioned from the effects of the crisis. While many Latin banks do not depend as much on foreign credit and thus are less vulnerable to the credit crunch than richer nations, suppliers' credits are key for exports, foreign loans are crucial for infrastructure projects and foreign investment remains important for many economies (Mexico, Brazil, Colombia, Peru). Since much of the impressive recent growth has been commodity driven, the fall in prices can be devastating for countries like Peru, Venezuela, Ecuador and Argentina.

Even Brazil, which has the region's most diversified and sophisticated export base, is also an enormous producer of food exports and minerals and is being shaken by falling-hard currency earnings. The country that is perhaps the least sensitive to commodity prices--Mexico, because of the large volume of its manufacturing sales abroad--is the most sensitive to the swings and lurches of the U.S. economy, since 90 percent of its exports and tourism, and 100 percent of its remittances, are American-based.

Another unnoticed vulnerability is that, as Latin economies globalized over the past two decades, the number of local companies listed in New York rose rapidly. Thirty-eight Brazilian companies are quoted on Wall Street; 20 Mexican ones are; 15 Chilean; and a growing number of Peruvian, Colombian and Argentine corporations are too. They all represent large proportions of the market capitalization in their own home exchanges (Telmex alone accounts for nearly 50 percent of the Mexican Bolsa's trading), and they all track the Dow with great fidelity.

If the Dow plunges, their value follows in New York, the fall spreads to São Paulo, and so on, and local investors flee the local exchanges and buy what the rich in Latin America have always bought: dollars. The currency plummets, central banks raise interest rates to retain money at home, and a domestic debt bubble bursts: mortgages, automobile loans and credit-card balances become unsustainable. All of this is beginning to happen, and will probably get worse before it improves.

This is a stark reminder of how contagion works. One of the other silly ideas about the fallout was that in the past, crises began in Latin America and spread north, making this year a very new scenario. Not so. It was Paul Volcker's 1980 decision to raise interest rates that led, two years on, to the Latin debt crisis, which never really affected the creditor countries. The 1987 stock-market collapse began on Wall Street, spread to Mexico and throughout Latin America, but never returned; finally, the Mexican collapse of 1994–95, as well as the Brazilian devaluation of 1997, occurred during one of the longest economic booms in modern U.S. history. All crises that begin in the rich countries spread south; those that originate in the south rarely travel north.

Some countries will emerge from the current crisis better than others. Mexico, Chile, Brazil and Uruguay should manage just fine, with only bruises and scrapes; others will weather the storm, though suffering greater harm (Colombia, Peru). But others will incur severe damage: Venezuela, Bolivia, Ecuador, Central America and the Caribbean. With too much delay, all of their leaders have finally acknowledged what everybody knew: no crisis with this impact in the United States and Europe could avoid ravaging Latin America as well. Now all these leaders have to do is decide how to protect their societies, and how to pick up the pieces when the time comes.

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