Overview: Brace for Snapback

Latin America is booming. Government officials across the region are boosting their 2007 GDP growth forecasts. The Chileans are projecting 6%+ growth. The Colombians are talking about an annual growth rate of almost 8%. President Kirchner recently announced that Argentina’s growth rate would be in the 8% range, and Brazil’s level of economic activity is approaching 5%. Myopically focused on their own situation, regional leaders, policymakers and most local analysts have no realization that the deleveraging of the U.S. financial system is going to reverberate throughout the globe—and that Latin America will not be immune.

Although the recent panic in the marketplace was subdued by the expectations that the Federal Reserve would slash interest rates at its next meeting, the global deleveraging process is only beginning. There is no confidence in the credit quality of most collateralized obligations. Financial institutions around the globe are unable to move many of the asset-backed derivatives that they have on their balance sheets, and the issuance of new instruments will most likely evaporate. This is very bad news for the U.S. consumer. Two steps from insolvency, North American consumers need access to financing to satisfy their gluttonous appetites. However, the inability to stuff international investors with repackaged mortgages, credit card receivables and automobile loans means that U.S. consumption will falter. However, the U.S. represents half of global demand and there are no signs that anyone else wants to take up the slack created by the downturn in North America. Therefore, there are going to be global repercussions.

Asia’s economic model of promoting external demand over domestic consumption means that it will have to idle capacity when the U.S. slowdown becomes more apparent. Japan is already feeling the heat. The July trade data showed a sharp slowdown in exports to the U.S., leading to a reduction in its trade surplus. However, the contraction of the U.S. housing bubble is just starting. One cannot imagine the fallout that will occur when the U.S. (and global) housing markets enter full-fledged downturns. Unfortunately, this is on the horizon, with credit facilities evaporating, mortgage companies shedding staff and declaring bankruptcies, and financial institutions introducing stricter lending parameters. Therefore, a global slowdown is inevitable. Unfortunately, no one in Latin America seems to care.

It is true that the region’s macroeconomic conditions and credit indicators are sound. Debt levels are low. Most of the countries have trade and current account surpluses. International reserves are high, and fiscal balances are in the black. Nevertheless, most of the countries in the region depend on external demand to sustain their levels of economic activity. No Latin American country, not even Cuba, is immune from a global cyclical downturn. Therefore, a Latin America slowdown is close on the horizon. Unfortunately, the deceleration may be severe, due to the governments’ unwillingness to prepare for the correction. Most Latin American governments are embarked on ambitious investment and spending programs. Most of the countries are in the midst of unprecedented credit booms.  The spirit of fiscal prudence is fading. However, failure to move towards a more prudent mix means that policy makers will have to over-correct when the problems become evident, leading to a sharper economic slowdown or a sudden stop. Therefore, it is time to become defensive on Latin America. The region may be strong, but it cannot stand alone.