By Dr. Vince Hooper – The current political instability in South America could spread to neighboring countries and end in a full blown economic and financial crisis. South America’s problems stem from very poor governance structures over a very long period of time and weak rule of law, which has rendered it a sitting duck when it comes to involvement by the International Monetary Fund and World Bank in terms of economic reforms and loan terms. Not only was it influenced of a tsunami of financial liberalization in the 1990s through Washington Consensus but has had countries ineffectively dollarize causing further inconveniences to certain parties.
It is widely accepted that many of South America’s economic and financial problems has been agitated by the effects of globalization purveyed by the United States and the the IMF and World Bank – superpowers in today’s world economy.
Nevertheless, the economic and financial challenges facing South America are being driven again by external policy factors, in the main, within the context of political instability.
The GFC – Global Financial Crisis of 2007 – has been effectively exported to emerging economies such as those in South America through QE – Quantitative Easing or printing money. QE, associated with very low interest rates with negative real interest rates in South America created a debt bubble to emerge denominated in US dollars. As the US economy has gradually climbed slowly out of recession, global economic growth has ticked up and US interest rates are expected to increase.
Against a back-drop of political instability in South America, we see a weakening of exchange rates there against the US dollar, across the board. This means that foreign debt in South America is more expensive to repay both in-terms of principal and interest payments to western banks which may lead to a wave of debt defaults especially given that the major credit rating agencies have generally downgraded the South American region. South American economies are now at a tipping point.
This debt problem has been exacerbated by moral hazard, a situation where the banks win in good times and the tax-payer loses in bad ones, a phenomenon highlighted by a succession of IMF and World Bank bail-outs in the past in South America, as well as an extenuated period of cheap money.
Whilst the Venezuela political regime has come under the wrath of its South American neighbors suspending it from Mercosur – the South American trading bloc is exposed to contagion effects from both inside and outside. Within the globalization context, South America has moved to much greater regional integration over the past two decades which exposes it greatly to both regional and global shocks.
All South American countries have also borrowed heavily and exposed to an unwinding of QE, with accompanying higher interest rates. In many regards, QE is now exporting the GFC 2007/2008 to South America because global interest rates have remained too low for far too long. QE or Monetary Socialism has distorted the risk-return relationship across all global markets, coupled with moral hazard, it has caused long-term damage to the global economy which is going to take a long time to unravel.
Brazil’s economy is fragile, suffering the effects of a loss decade with high unemployment of 1 in 4, a government budget deficit of 10% of GDP and political instability propelling outsiders into power and fragmenting the power-base. There have been major cuts to infrastructure projects; law and order; education, health, social and public priorities; and research and development. This trend in Brazil, the South American economic giant is mirrored throughout the South American continent. Argentina faces a bumpy ride with its current economy wide structural reforms.
Commodities & Crisis
The cost of borrowing for many South American countries is increasing sharply as commodity prices slowly recover and this feeds through to credit rating. South America is over exposed to commodities, for example Chile’s copper exports comprise 40% of the total. Chile is often thought of as a bastion of stability in South America but faces major economic uncertainty.
One of the major recent upsets for the South American economies has been the collapse in the commodity super cycle in 2014/2015 across all key commodity sectors. This major downturn was associated by a decrease in China’s economic growth, oversupply of oil and excessive market speculation by global banks playing the commodities markets with cheap QE money.
The economic and financial crisis facing South America is different to those in the past, in the sense that the recovery trajectory is likely to be much shallower and longer than previous economic crisis because of the current weakness caused by a decade of austerity.
In the past, South America has been able to export its way out of trouble with economies being commodity driven. However, weakness in commodity prices has persisted and still on a bumpy road. This is reflected in the shipping Baltic Dry Index, the global barometer of world trade which continues to plumb new depths, which also reflects overcapacity in the global shipping fleet and weak commodity prices.
Thus the outlook for South America is not positive in the short to medium term which is being compounded by internal political instability, in general, on the continent and the unwinding of QE in the US, the commodity collapse and China slowdown which has created additional risks. With the trigger effects of global interest rises, recessional risks in South America are increasing which coupled with structural economic fragility could cause a major economic and financial meltdown in the not so distant future.
Very little, if anything can be done to stop this impending global shock.