Financial Crisis Brewing

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Sunday, March 25, 2001 Financial Crisis Brewing

By WALTER RUSSELL MEAD

NEW YORK--Hypnotized by the Nasdaq's worst calendar year ever and the Dow Jones' brief visit to bear-market land, most U.S. citizens have paid little attention to the storm clouds rising over the international economy. That could be a mistake. Japan's continuing economic decline is absorbing more and more high-level Washington attention; Asian economies, still fragile after the 1997-98 financial crisis, are reeling under the impact of the slowdowns in the United States and Japan; a Turkish financial crisis that began late last month raises basic questions about the health and stability of one of America's most important allies.

However, as important as all these problems are, a new Latin crisis is beginning to look ominously possible. A financial meltdown in Latin America, affecting countries like Argentina, Brazil and Mexico, could create major social, economic and political problems for the United States.

Start with Argentina, where economic problems are causing one political upheaval after another. Ten years ago, in an effort to stop decades of inflation and hyperinflation, Argentina adopted a stringent "dollar convertibility" program. Since 1991, the Argentine peso has been set equal to one dollar. At the same time, the country embarked on an ambitious program of privatization and market-oriented reforms. At first, the results were promising. Inflation dropped from more than 3,000% a year in 1989 to -0.8% last year, and GDP growth averaged 6.2% during the 1990s.

Then trouble came. The high U.S. dollar made Argentine exports expensive. The national debt ballooned--at more than 50% of gross domestic product, it is one of the largest in Latin America--and as unemployment rose to 14.7%, the economy went into a recession.

Argentina is trapped. Free-market re-forms are now so unpopular that governments can't get them through Congress. Foreign creditors are nervous, demanding higher interest rates to compensate them for the risk that Argentina will devalue its currency or default on its debt. High interest rates and a lack of progress on reforms help keep the economy in recession.

Where this will end up isn't clear, but it's getting harder and harder to imagine a happy ending. Already, Argentina's problems are spilling over into Brazil. Investors have been selling Brazil's currency, the real, out of fear that Argentina's economic and currency problems will weaken its neighbor. By early this week, the real had fallen 10% since Jan. 1, more than twice the decline that the central bank had projected for the whole year. Sooner or later, currency weakness could force the Brazilians to raise interest rates as well, crippling an already weakened Brazilian stock market and threatening the country with a return to recession as well.

Mexico, thanks largely to the North American Free Trade Agreement, doesn't face a short-term economic meltdown yet. But with 89% of its exports headed for the United States, Mexico is uniquely vulnerable to a U.S. recession. Already the economic slowdown in the U.S. has caused the Mexican equivalent of the Federal Reserve to scale down its growth projections for the Mexican economy this year from 4.5% to 3.5%.

That matters. Most Americans forget what most Mexicans know: Despite more than 20 years of economic "reforms," most Mexicans are worse off today than they were in 1980. Wages adjusted for inflation have dropped 25% since 1980, and NAFTA, despite the increase in jobs that has come with it, hasn't stopped the bleeding.

Social conditions in Mexico can only be described as horrendous. This partly reflects the country's underdevelopment, but it also reflects an unequal distribution of wealth.

Take infant mortality: 28 out of every 1,000 Mexican babies die soon after birth. Cuba, with half Mexico's GDP per person, has an infant mortality rate of only 7. Forty percent of Mexicans are poor; 26% are classified as living in "abject" poverty.

President Vicente Fox's administration knows that changing these numbers is the key to Mexico's economic, social and political future. His new government, the first truly democratically elected one in Mexico in decades, has unveiled a series of ambitious programs to target education and infrastructure spending on the poor. Fox wants to see ordinary working families in Mexico have opportunities to buy their own homes with affordable mortgages, and he wants to see high school and college education open to all.

The trouble is, a slowing Mexican economy can't deliver the goods. To make real progress on reducing poverty and raising wages, most experts think Mexico needs growth of 7% a year. That is an ambitious target under any circumstances; with a U.S. slowdown or, worse, a recession, that target is completely out of reach.

Hopefully, Mexico, Brazil and Argentina will muddle through their latest set of problems without a full-fledged crisis exploding. But if it does, or even if their economies sputter along without providing rising living standards for most people, the U.S. government is going to have some first-class problems on its hands.

For the last 20 years, the political leadership in most Latin American countries has believed that free-market economics would improve living standards while democratic governments would protect property rights and install the rule of law. Because of those beliefs, countries like Argentina, Chile, Mexico and Brazil have moved away from military or one-party rule and freed their economies from state control.

But the long string of economic crises has begun to undermine these beliefs. In some countries, like oil-rich Venezuela, free elections have been won by politicians who reject both free markets and the conventional rule of law. In others, like Colombia, a combination of mass poverty, narco-trafficking and weak institutions is leading to anarchy and civil war. Countries like Ecuador and Peru seem to be moving away from stable democratic governments and sound economic policies.

Part of what is happening is that the new democracy in Latin America makes it harder for governments to follow economic policies that call for sacrifices today for the sake of greater prosperity tomorrow. Dictatorships and one-party states can do what they like; that is how Gen. Augusto Pinochet introduced economic reform in Chile, and that is how Mexico's Institutional Revolutionary Party, or PRI, started the modernization of the Mexican economy.

But once democracy takes hold, the people must be heard. Presidents who back unpopular policies can't get their proposals through national congresses. Politicians who back unpopular presidents lose elections.

In a democracy, economic policy has to work fast and it has to work for most people. Unfortunately, in many Latin American countries, the present set of economic policies is not working fast enough.

This leaves the Bush administration and the United States with a difficult question: Assuming we want Latin America to grow into a group of rich, peaceful and stable democracies, what economic policies should we support?

Clearly, what we are doing now isn't enough. The whole program of political and economic reform in Latin America wobbles every time stock markets go down or interest rates go up. Over the medium term, free-market economics is losing ground in Latin American public opinion, not gaining it.

Latin America needs a development strategy that Latin American voters will support over the long haul. Mexico's Fox, with his emphasis on improving the living standards of ordinary people and providing special help for the poor, has the right idea. To succeed, he is going to need understanding and help from Washington. Let's hope he gets it--and let's hope that his brand of pro-market, pro-family economics works in Mexico and points the way to a new and sustainable regional approach.

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Walter Russell Mead Is a Contributing Editor to Opinion and a Senior Fellow at the Council on Foreign Relations. he Is the Author of "Mortal Splendor: the American Empire in Transition."

http://www.latimes.com/cgi-bin/print.cgi



-- Martin Thompson (mthom1927@aol.com), March 26, 2001


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