China: the strategic partner for recovery in Latin America’s Southern Cone

The U.S. economy will lose strength as the engine of the global economy but will increase its competitiveness as an exporter of manufactured goods, and China will replace it as the driver of the global economy, mainly during the initial stages of the recovery. Consequently, given the Chinese imports structure, we dare predict that in the short-term, the countries producing commodities, mainly food, energy and certain minerals, will be in a clearly advantageous position with respect to the rest of the world.
There is a quasi unanimous consensus that the global contraction is over and that, timidly, a fragile recovery is starting, mainly in the system´s epicenter: the U.S. Following 20 months of a deep financial and economic global crisis, bordering on a depression, the veil is being lifted and we witness the skeleton of a seriously damaged capitalist system –in intensive care and on a respirator— but still showing signs of life and progressing towards recovery. The prognosis is still uncertain, as is the period of hospitalization that will be required of the patient before he can be unhooked from the respirator and walk unassisted by the U.S. government by way of its stimulus and rescue packages. In such regard, when lifting the veil, we see the shocking indicators showing the starting point of the recovery.

Like after a tsunami, when the waters recede, we find a U.S. economy with 10% unemployment and even higher percentages in other developed economies; a 9.3% public deficit in the U.S., of 1.4 trillion, and averaging 9% in all the OECD member countries; record bankruptcies among corporations and banks, mainly in the U.S.; a 20% drop in world trade and growing signs of protectionism; a sharp fall in remittances to Latin American homes, and according to the U.N, 100 million more poor in the world. These are just some of the most shocking figures that characterize the global economy at the end of the crisis and the beginning of its recovery.

The recovery process will not be territorially homogeneous, much like the crisis wasn’t. This article attempts to analyze the global recovery’s positioning in our region: Latin America’s Southern Cone. In initiating this reflection, we must put forth a question with a very complex answer, which will try to simplify by focusing on the crux: How did the global economic engine work until 2007, and how will it work from 2010, for several years to come?

Prior to the crisis, the global economic engine was powered by a single and powerful driver: the insatiable appetite of the U.S. consumer and the bellicosity of the government headed by George W. Bush. Jointly they generated strong global demand, backed, in the case of U.S. homes, by their growing wealth as a result of the sustained increase in the price of homes and stocks, and in the case of military spending, by the sustained expansion of the public deficit. The growth of private consumption was fueled by low-rate banking credit. In turn, the banks funded themselves on the capital markets by means of creating sophisticated financial products, derivatives on derivatives, which in turn were based on mortgages generated with the loans they granted themselves. In the case of public spending, the deficit was funded by Treasury Bonds issuance purchased by central banks, sovereign funds and private investors, all of them in pursuit of reserve and safety assets. For its part, the Fed generated the liquidity, by issuing the dollars required to lubricate an entire system working in overdrive, driven by excessive consumption and greed. In early 2008 the global engine overheated and collapsed, giving rise to the debacle over the bursting of the bubble of subprime mortgages, followed by the collapse of home and stock prices.

In the years to come, of weak recovery, the global economy’s engine will significantly reduce its revolutions and therefore its activity level. U.S. household consumption has ceased to be the main driver with speculation emerging on various alternatives for the potential replacement, at least for the early years of the recovery.

Within the U.S. economy, the driver in the initial stages of the recovery will be public spending. The drop in private consumption has been replaced to a large extent by the public consumption generated by the Obama stimulus plan, the sector-specific rescue plans and the considerable injection of funds into the banking system –which the banks have used to capitalize themselves rather than to issue loans, as the Fed intended. This is a languid scenario for the U.S. economy, until a rebirth of credit and consumer confidence. In the meantime, more issuance and placement of Treasury Bonds, but less confidence in their attributes as reserve assets; a depreciation of the dollar and the increase in competitiveness of U.S. exports. In sum, for the U.S. economy, the future holds a very fragile recovery, initially driven by government spending, and a dangerous choice to make: to withdraw the stimulus packages and face a slower recovery; or to maintain the stimulus and face a greater deficit, feeding the ghost of inflation.

Globally, the dynamics of the recovery can be perceived more clearly. The Chinese economy will be the great driver of the world’s economic activity. China has not stopped growing during the entre contraction phase of the crisis, and recently announced a growth rate of 8.9% during the third quarter, which would place the overall 2009 rate at 8%, which made the Chinese government affirm its active fiscal policy and expansionary monetary policy. Jointly with the surprising third quarter GDP increase, other indicators of its economy were disclosed that confirm the solidity of its expansion: an annual 34% rise in fixed assets investment, a 15.5% increase in retail sales, and growth of 13.9% in industrial production for the 12-month period to the end of September, an increase over the 12.3% seen as of the close of August. It should be noted that when it felt the initial impacts of the recession –manifested as a 24% drop in exports in a country where foreign trade accounts for 60% of GDP– China reacted rapidly with a stimulus plan to the tune of 580 billion dollars which were entirely channeled by the banks as credit to consumers and small and medium businesses. Thus, China appears to emerge as the engine that will jumpstart the global economy and it will likely maintain this status over the initial months, or even years of the recovery The formidable post-crisis irony is that a centrally planned economy, led by a Communist Party will act as the driver in the recovery of the global capitalist system. But China is not alone in this task, according to the latest available indicators, two emerging economies have initiated vigorously their recovery: India and Brazil.

Based on these foregoing reflections, we can anticipate one conclusion. The U.S. economy will lose strength as the engine of the global economy but will increase its competitiveness as an exporter of manufactured goods, and China will replace it as the driver of the global economy, mainly during the initial stages of the recovery. Consequently, given the Chinese imports structure, we dare predict that in the short-term, the countries producing commodities, mainly food, energy and certain minerals, will be in a clearly advantageous position with respect to the rest of the world.

Latin America’s Southern Cone region produces one third of the grains consumed worldwide, half the meat exported around the world, and it has formidable hydrocarbon reserves. Chile produces one third of the copper consumed by China, and its price has climbed 127% so far in 2009. Additionally, the Southern Cone has a regional engine in Brazil, which may be a global engine as well, and which leads the regional recovery through the creation of a market for goods and services whose trade is benefitted by the advantages provided by the MERCOSUR free-trade zone. Further, the five countries included in the Southern Cone region (Argentina, Brazil, Paraguay and Uruguay, all members of Mercosur, plus Chile) entered the crisis with their accounts in good shape: a fiscal surplus, acceptable levels of indebtedness with regards to GDP, high reserves levels and a stable banking system sufficiently capitalized. The near future for the Southern Cone is promising, the recovery will arrive earlier and will manifest itself in 2010 in growth rates in the order of 3% to 4%. This year, Brazil initiated its recovery and capital inflows and foreign investment are being restored; Uruguay is one of few countries in the world that will show a slightly positive growth rate in 2009; Argentina has reverted its capital flight and is leaving behind the constraining effects of its default and its debt with the Paris Club. We are approaching a promising 2010. In order to consolidate these trends it will be necessary to acknowledge that China is the strategic partner par excellence for Latin America’s Southern Cone, and based on this conclusion, to accordingly coordinate the region’s trade policy.

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