Essay on To what extent the current financial crisis is different from the previous crises for Latin American countries?

Submitted By danilolimoeiro
Words: 2961
Pages: 12

Regarding Latin America, to what extent the current financial crisis is different from the previous crises?
In September of 2008, a feeling of ‘there we go again’ hit Latin American countries (LACs), as it became clear that ‘decoupling’ would not work and that the US subprime crisis would spill over the rest of the world economy. In a region where ‘normality’ had been much more the exception and periods of either crisis or crisis adjustment have been the rule in the last three decades, the interruption of the commodities bonanza by a foreign crisis reminded Latin Americans of their bitter past. However, as the crisis unfolds, there are some clear signs that this will not be a usual crisis for Latin America. Although it may be too early for definitive evaluations, one can attempt to identify what are the main differences, up to this point, between this crisis and previous ones and what these differences imply.
In this essay, we will argue that the current crisis presents significant differences from previous crises, namely, the 1980s Debt Crisis and the emerging market crises of the 1990s/early 2000s that hit Mexico, Brazil and Argentina. We argue that the main differences can be summarized in four: i) Latin American countries are not at the epicenter of the turmoil; ii) as a consequence, one can expect less intense effects and changes in channels of transmission, which will be mostly trade-related; iii) the region is better prepared to cope with the consequences of the crisis; iv) a difference that has been going unremarked, but which is equally important, is that LACs did not resort to IMF adjustment/stabilization plans1, which means that they will maintain the governability over their economic and development policies in the aftermath of the crisis. In order to substantiate this argument, this essay will i) examine past crises and the current crisis; ii) point out their differences; iii) conclude with a discussion of what are the main implications of those differences in terms of policies.
1. Past Crises in Latin America – 1980s Debt Crisis, 1990s Mexico, Brazil and Argentina crises As argued by Palma, past crises involving emerging economies (EEs) had as a common feature: “over-lending” from financial institutions and “over-borrowing” from EEs, resulting, however, in asymmetric effects for both parts, that is to say, lenders emerged relatively unhurt and borrowers bore most of the adjustment cost.2 In short, the dynamics of these crises can be described as follows: an excess of liquidity in international capital market, operating at an under-regulated environment, will seek high-return investment opportunities. Those capitals tend to exaggerate favorable signs at EEs and massively direct resources to these countries, expecting – and actually achieving – returns much higher than investments in rich economies. On the other hand, EEs do not resist to the temptation of having easy access to that large amount of resources and, as the supply of easy capital generates its own demand, these countries accept huge amounts of international capital. This lead to what Greenspan called ‘irrational exuberance’: financial institutions lend more than prudent risk assessment would allow and EEs borrow more than sensible long-term economic management would advise3. To sum up using Palma’s words, under-regulated financial markets tend to exaggerate good news.4 This apparent win-win situation turns upside down as a result of sudden change in international or domestic environment. This can be caused by sudden increase in international interest rates or recurrent deterioration of the balance of payment. Events as default declaration by a country or low rate from risk assessment agencies trigger panic in international capital markets, which is exacerbated by a combination of contagion and herd-behavior, leading to immense capital flight or total halt of capital inflows to EEs. As Broughton has put, financial markets initially…