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The U.S. Financial Crisis and Latin America

By Mohamed El-Khawas

Guyana Journal, December 2008

The banking crisis hit the U.S. like a tsunami. Its aftershocks have turned it into a global crisis affecting every region in the world. At the outset, Latin American governments were quick to say that the U.S. crisis would not have an impact on their nations. They thought that the measures that they had implemented to shore up their economies in recent years would help them weather the storm. They were wrong. Within weeks, they reversed their stance and acknowledged that the U.S. financial crisis might hurt their economies, which had relied heavily on growing foreign investment and rising commodity prices. According to the Permanent Secretariat of the Latin American and Caribbean Economic system (SELA), the current crisis could decrease global demand for goods, reduce export revenues, and lower rates of economic growth. This situation could jeopardize the economic gains that these countries have made over the past five years.

It did not take long for the U.S. financial crisis to spill across its border and affect Latin America. U.S. pension systems and hedge funds, which had invested heavily in the Latin American emerging market, reduced share holdings and pulled their money out of the region amidst credit tightening and fears of recession. Consequently, many Latin American stock markets took a big hit and suffered huge losses as the value of national currencies significantly dropped against the U.S. dollar. In Brazil, the Bovespa Index plunged 12 percent in a week, forcing the government to suspend trading. Brazilian companies, which had borrowed heavily to finance the expansion during the economic boom, are now unable to obtain lines of credit from overseas banks to pay back their loans. The economic downturn has led Finance Minister Paulo Bernardo to warn that the government might be forced to reduce spending on many programs. The outflow of foreign capital harms their economies, denying both the public and private sectors the resources they need to expand their investment projects. In response, some governments have taken measures to redress the situation. For example, Mexico's Central Bank auctioned $11 billion in foreign currency reserves in an effort to shore up the national currency against the U.S. dollar.

In Argentina, President Cristina Fernandez de Kirchner announced her plan to nationalize the private pension system to protect retirees against market volatility. The nation's stock market reacted strongly to her announcement. The Marvel Index dropped 24 percent in two days and investors dumped Argentine bonds. Opposition parties and economists were critical of such a move and argued that she is going to use the $25 billion in the pension funds to finance the cash-strapped government. A month later, Congress approved the pension nationalization. It is predicted that financial conditions could worsen further as more capital leaves the country and investor confidence erodes. President Kirchner is caught between a rock and hard place. Buenos Aires is not eligible to receive any emergency loans from the International Monetary Fund (IMF) or have access to credit markets because of its 2001 debt default, raising the prospect of another default.

The weight of a global economic slowdown is especially felt among commodity exporting countries, which had experienced high global demand for Latin American agricultural products and minerals over the past five years. The sudden drop in demand pushes prices down and reduces export income. For example, the price of soybeans in the international market has fallen by 44 percent in three months, cutting Argentina's tax revenues by nearly $3 billion. Mexico is hit the hardest because it is heavily dependent on the U.S. market for the sale of its products. On the other hand, Brazil and Peru will fare better for different reasons. Brazil has a diversified market, which includes trading with other Latin American countries as well as with China. Peru's growth is anchored in domestic demand plus it has saved a lot of the export income generated by high mineral prices.

Venezuela faces greater risk because its economy depends on the global oil market. Oil sales account for 95 percent of Venezuela's export exchange earnings. The price of a barrel of crude oil dropped on the New York Mercantile Exchange from a high of $147 last July to under $40 in December, resulting in nearly 70 percent reduction in government revenue. If the oil price continues to fall, it would have a severe effect on the country's economy. President Hugo Chavez will be forced to reduce spending on the domestic programs that have made him popular among poor and working class people. For now, he believes that his country does not have to worry about an economic downturn because it has $40 billion in Central Bank reserves and the president's office has billions of discretionary funds. Yet because he also is counting on exporting about a million and half barrels of oil daily to the U.S., Venezuela will be in trouble if the U.S. economic meltdown continues. A global recession has cut the global oil demand by Venezuela's major trading partners (U.S. and China) as plants close and workers are laid off. Lower demand means lower prices. As a result, Venezuela will have unfavorable balance of trade payments. Chavez will be obliged to reconsider the financial commitments he had made to other Latin American countries, including plans to build oil pipelines across Ecuador and a deep-seaport on the Pacific Ocean there to ship Venezuelan oil to China.

Latin American governments have no choice but to adjust to the new economic realities. They are faced with many challenges in financing debt or covering shortfalls in current expenditures because commercial banks are not giving out loans, and bonds will be hard to arrange at a time when the financial market is in turmoil. They have few options because foreign aid from regional partners is not possible. The global crisis has not left any nation untouched. They could dip into foreign currency reserves, cut spending or raise taxes to close budget deficits. Under these circumstances, regional and international financial institutions should step up to the plate and help these governments minimize the impact of the global crisis.

The IMF's slow response to the crisis has put a burden on regional organizations to help their member states. The Inter-American Development Bank (IDB), the Latin American Reserves Fund, and the Andean Development Corporation have put together a $10.7 billion emergency fund to assist small Latin American countries and other less developed nations in the region to ease cash-flow problems and to avoid recession. One-or two-year loans will be given to help these governments stay afloat. The IDB also announced that it would invest more in Brazil, Chile and Mexico in an attempt to stimulate regional economic growth. Furthermore, President Robert B. Zoellick announced that the World Bank is ready to assist Latin American countries to boost cash supply and to safeguard employment.

The IMF recently announced that it is offering short-term loans to Latin America's emerging nations to prevent the collapse of their banking systems. Brazil, whose currency has lost nearly a third of its value against the U.S. dollar, can get a $15 billion three-month loan. If the loan is paid back in full and on time, Sao Paulo can borrow three more times during the year.

The future of Latin American economic growth depends on how long it will take the U.S. to put its financial house in order and its economy to rebound. A quick recovery by Washington is not possible because the $700 billion bailout plan has not succeeded in stopping the bleeding of financial institutions or restoring investor's confidence on Wall Street. The future is uncertain and the risk is great. It is increasingly evident that the global financial system will not survive the current crisis. As Brazil's President Luiz Inacio Lula da Silva put it, "This system collapsed like a house of cards that dragged down with it the dogmatic faith in the principles of nonintervention by the state in the economy." He added, "We need a new, more open and participative governance." The Group of 20 met in Washington in mid November and agreed to reform the broken system. The U.S. is no longer in a position to single handedly restructure the new financial system as it did at Bretton Woods in New Hampshire in 1944. Differences between the U.S. and the European Union give Latin Americans (Argentina and Brazil) and Asians (China and India) – members of the G-20 – an opportunity to play a crucial role in shaping the new global financial system.

Dr. Mohamed El-Khawas is a professor in the Department of Urban Affairs, Social Sciences, and Social Work at the University of the District of Columbia, Washington, D.C.

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