South America: Can Recession Be Avoided?
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Can South America escape the wrath of the economic and financial storms that have their epicenter in the United States? Since the financial meltdown began in mid-September, the bond markets of most of the region (Brazil, Argentina, Colombia, Venezuela) have been hit, as well as most of their stock markets and a number of currencies. The steep drop in commodity prices in recent months has also reduced export and government revenue to a number of countries (Argentina, Brazil, Ecuador, Venezuela, Peru, Chile) where previously high prices of agricultural crops, minerals, and hydrocarbons has contributed to a growth spurt over the last few years. The old adage that "When America gets a cold, Latin America catches pneumonia" has been widely cited.However, there is good reason to believe that South America, in particular, can weather this storm with minimal damage if it adopts the right macro-economic policies. First, these countries are not very much tied to the U.S. economy, which is in the midst of a deep recession. Exports from Brazil and Argentina to the United States, for example, are less than one percent of those countries' economies. Second, the financial institutions of these countries, for various reasons, did not buy the toxic mortgage-backed securities and other "troubled assets" that have tanked U.S. and even European banks, nor did they engage in the kind of over-leveraging and other risky practices that have brought down the U.S. financial system.So there is no reason to expect South America to face the kinds of economic troubles that currently plague the United States. However, South America is still linked to the world economy through trade and investment, and will be affected by the world slowdown. It will therefore need to pursue expansionary monetary and especially fiscal policies -- just as the rich countries are doing -- in order to maintain healthy economic growth.China did this during the Asian economic crisis ten years ago, and maintained solid growth while its neighbors -- Indonesia, South Korea, Thailand and others -- suffered serious losses of output and employment and watched tens of millions sink into poverty. The Chinese temporarily changed their economic strategy and invested hundreds of billions of dollars in public works and infrastructure. They are responding similarly to the current crisis, deciding this week to increase spending on infrastructure, transportation, and social welfare programs over the next two years by $587 billion.Developing countries face one constraint that the United States or Europe does not have when they choose to stimulate their economies: their currencies are not "hard" currencies that the rest of the world accepts, and so they must have enough foreign exchange to avoid a balance of payments crisis. Fortunately, South America is currently well situated: most of the region has large amounts of reserves. Bolivia, the poorest South American country, has more reserves relative to their economy than China does. But the region is still subject to irrational fears that can destabilize their financial systems. For example, none of these countries are going to default on their sovereign debt, yet most of their bond prices crashed and yields soared when the financial crisis began.For this reason, South America could use a stabilization fund that countries could draw on in order guarantee financial stability. It would be very unlikely that such a fund would actually be used -- its existence would negate the need to draw on it. Washington and its partners such as the UK are trying to raise money from the countries with large reserves, such as the oil-rich Gulf states. But they want any stabilization arrangements to go through the IMF.This is too risky for South America, and it is unnecessary. The IMF badly mishandled the Asian crisis and its contagion a decade ago, causing major damage. They can do the same thing by imposing the wrong conditions on lending today, as well as by playing favorites among countries in need. (There is no reason to scold or criticize the Fund; its managers answer to the U.S. Treasury Department.)South America should appeal directly to countries that have large amounts of excess foreign exchange reserves, such as China ($1900 billion), Russia ($556 billion ), Abu Dhabi (estimated $875 billion) and others for a stabilization fund that is outside of the IMF. The details are less important than that it should be established quickly. One of the worst things that the U.S. Treasury and IMF did during the Asian crisis was to force countries in the region to abandon their plans for a regional "Asian Monetary Fund" and then to delay the necessary balance of payments support until most of the economic damage had been done.Of course, Washington will (and already is) use its political clout to muscle the excess-reserve countries into going through the IMF. But South America has some political clout of its own. Brazil is a major player on the world stage. Venezuela and Ecuador are members of OPEC, where much of the world's excess reserves are, and Venezuela is a major oil exporter. China is becoming a strategic partner in Latin America and is stepping up its investment there. Russia is also becoming more involved in the region.On a separate track, the South American governments should also lobby the U.S. Treasury Department to prohibit onerous conditions from being attached to any IMF lending that takes place. The only legitimate purpose of the IMF providing balance of payments support is so that countries can avoid the harsh austerity and recession-deepening measures that might have to be implemented in the absence of foreign exchange credits. Lending that imposes contractionary conditions in a downturn is inexcusable. And inflation is not a serious threat right now, in the face of a global recession.South America can grow right through this world recession, just as China will. Just as it is true for the rich countries, expansionary macroeconomic policies will be key. But some outside help for a balance of payments support fund could play an important role in making sure that this happens.