A Financial Times headline summarizes the perspective of Argentines: "Globalization proves a mirage as country slides into isolation." And for the first half of 2002, many analysts thought that Brazil and the rest of the region could quietly slip away from Argentina’s agony.
They figured that somehow, the rest of the region and the world could ignore the fact that an economy of 30 million people was sinking into complete breakdown. The latest head of the Argentine central bank resigned in June 2002, citing growing fears of "contagion."
But the Argentine disease seems to be slowly — but steadily — spreading to other nations in the region. Like Argentina last year, Brazil is suffering from falling access to foreign liquidity. The Argentine meltdown, combined with a strong showing by the perennial left wing presidential candidate, Luiz Inácio "Lula" da Silva, has created a stampede for the door by foreign investors.
Lula, a socialist who favors a forced restructuring of Brazil’s foreign debt, has a commanding lead over the conservative candidates favored by the country’s foreign creditors.
It is some measure of the moral position of foreign investors that they fear the election of a populist candidate who dislikes the fact that Brazil spends more annually on foreign debt service than it does on internal infrastructure and health care.
Brazil’s economy is larger and far more resilient than that of its neighbor, yet the country cannot avoid default on its total debt of $344 billion if it loses access to the global capital markets.
Brazil has done many things right where Argentina failed — reducing public spending, restoring solvency to the banking system and cutting inflation to single digits. In contrast to Argentina, where the middle class contracted during the 1990s, Brazil's middle class has thrived. Furthermore, Brazil's social indicators improved, labor productivity surged and Brazilians as a whole became more affluent.
And yet, Brazil is now under attack, with a slowing economy, rising unemployment and plummeting investor confidence. Because of the erosion of confidence due to Argentina, the largest country in the hemisphere after the United States is now hostage to the fickle perceptions of the global investment community — a fact not helped by the glib comments by U.S. Treasury Secretary Paul O’Neill that Brazil did not merit international assistance.
If current political trends continue and Lula is victorious in October, it seems certain that Brazil will be forced into some type of foreign debt restructuring. Indeed, since the country needs to refinance $50 billion in debt between now and December, the increasingly adverse reaction of the markets to the prospect of a Lula victory could create a financial crisis before October’s poll, making Brazil’s financial stability the issue in the election.
As global investors back away from the stocks and bonds of all the Latin nations, the logical question to ask is: How will other nations in the region be affected by a second financial crisis in Brazil?
Already, the collapse of Argentina and the crisis in Brazil is having a negative wealth effect on Chile, which will eventually manifest itself into lower investment and consumption.
"Chile may be like an island, but it is not a separate planet," says Walter Molano, a veteran Latin market observer at BCP Securities. He worries that the entire region may lose access to the capital markets as the result of Argentina’s slow demise.
"The crisis is creating an interesting phenomenon in the southern cone of Latin America. The massive devaluation in Argentina — and the ongoing meltdown in Brazil’s real — is putting immense pressure on the exchange rates of the smaller countries and is forcing them to adjust. Uruguay was just forced to float its currency. The Chilean peso has been in freefall for the better part of June."
New credit available to Latin America is "evaporating" as investors flee the region. Mr. Molano says that the markets expect global financial institutions to reduce their lending to Brazil in 2002 by a third to a half of their current levels. Such a reduction in credit is occurring at the same time that the Brazilian economy is slowing down.
The absence of foreign capital may become prominent in the second half of the year when Brazilian firms try to finance some of their external obligations.
"Unfortunately, the situation may get worse the longer the Argentine crisis is prolonged," Mr. Molano concludes, although he notes with some irony that the Bush Administration has belatedly made overtures to end the crisis after a year of studied indifference.
In Mexico, the effect of Argentina is also being felt. Mexico’s currency has fallen 10% in the past six months, from 9 pesos per dollar immediately following the Argentine devaluation to almost 10.
This follows a two-year run when the peso was the strongest currency in the world, even appreciating against the mighty dollar.
Over the last 18 months, Mexico’s stock market was a stellar, double-digit gainer — this even as the country dragged through 6 quarters of recession and saw its terms of trade deteriorate, killing the country’s ability to export outside of the NAFTA bloc.
For those who recall that Mexico was supposed to be a job-creating, growth platform in the post-NAFTA world, the past couple of years are especially strange. The strong peso has tamed visible inflation — but at a cost.
Like the United States, corporate bankruptcies and defaults in Mexico are at record levels, continuing the process of capital destruction that has crippled the country’s job creation ability since the 1970s. And like Brazil, Mexico spends far more on foreign debt service than it does on building infrastructure and providing health services for its people.
As the financial crisis in Argentina, and now Brazil, infects heretofore solid credits like Chile and investment-grade Mexico, the accepted notion of extending the benefits of globalization to the nations of Latin America — and the rest of the developing world — is in question.
It is fashionable to blame the Bush Administration for "allowing" the Argentine crisis to unfold, but that gives politicians too much credit — and mistakes the symptom of Argentina with root causes.
The same vast financial and demographic forces that fueled the technology bubble in the United States also drove Argentina’s profligacy and eventual collapse. Washington thought it could ignore Argentina — and even use its agony as an example for other debtor nations.
But a debt default by Brazil and/or a serious financial meltdown in Mexico is another matter entirely — and will mark a considerable defeat for advocates of free trade and globalization.
Just as financial problems in Asia threatened the stability of markets around the world, the reduction in the supply of credit available to the Latin debtor nations may signal a larger global liquidity crisis that could spread to Asia and beyond.
If relative paragons of free-market virtue like Brazil, Chile and Mexico follow Argentina’s example, a number of established assumptions about free trade, foreign debt and economic growth could be changed forever.
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