Who: Riordan Roett, Sarita and Don Johnston Professor and Director of Western Hemisphere Studies, Johns Hopkins University, SAIS
Where: Occidental, 1475 Pennsylvania Avenue, N.W. Washington, D.C., August 17, 2009
On the Menu: Poached Norwegian salmon, Pennsylvania Avenue punch, and monetary and budget discipline.
Few people can match Professor Riordan Roett's experience observing Latin America from a choice perch in the nation's capital. His employer, the Paul H. Nitze School of Advanced International Studies -- which also happens to be my alma mater -- is within walking distance of the White House. The restaurant I chose for the interview also seems appropriate. Occidental is located in the historic Willard Hotel and boasts a self-important Washington ambiance reinforced by oil portraits of a half-dozen recent presidents and black-and-white photographs of old-time influence peddlers.
Its open-air patio is across the street from the Treasury building. Sure enough, once Roett starts recounting the sorry history of post-World War II economic failure in Latin America, I can't help noting uninspiring parallels with recent economic policies in this country.
Living above Their Means
Governments in the region, explains Roett, began by protecting domestic industries and spending lavishly on populist programs. They got cheap, easy and plentiful credit -- Citibank chairman Walter Wriston famously said at the time that countries don't go bust -- which helped them avoid hard decisions even when oil prices spiked after the oil shocks of the 1970s. Latin America kept settling its rising oil bill with borrowed money and went on spending.
"Antonio Delfim Netto, who supervised Brazil's borrowing program at the time, believed that Brazil could grow fast enough to outpace the increase in its debt burden," explains Roett. A similar belief shaped the reasoning elsewhere in the region.
But, somehow, the borrow-and-spend mentality failed to produce solid, sustainable growth. Then, when in the late 1970s Paul Volcker's Federal Reserve jacked up U.S. interest rates, adjustable rates on sovereign debt went up sharply and debt service suddenly became a problem. Mexico was the first country to go bankrupt in 1982, to be followed in short order by other nations in the region.
In the United States over the past decade, borrowing was not limited to the federal government, even though Washington certainly did its fair share of mortgaging America's future. U.S. consumers also went into hock -- primarily because, unlike their Latin American counterparts, they could run up credit card debt and obtain second mortgages on their homes. Just as Latin American countries during the first and second oil shocks of the 1970s, the United States kept importing more oil even as oil prices increased from around $10 per barrel in 1999 to a peak of $147 per barrel in May 2008. Americans kept on driving gas-guzzlers, charging their mounting gas bills to their credit cards. Washington also pursued populist policies, cutting taxes and encouraging debt-fueled private consumption.
Borrower of Last Resort
Since the advent of the economic crisis, the similarity between the United States today and Latin America in the 1970s has increased. U.S. households have lost their access to credit, but the federal government is now doing the borrowing for them, boosting the budget deficit in the current fiscal year to $1.6 trillion, while at the same time pursuing extremely loose monetary policy.
Just as in the case of Latin America, borrowing costs for the U.S. Treasury have been quite low. In the 1970s, international banks provided new syndicated loans to the likes of Brazil, Argentina and Mexico because OPEC countries kept earning ever-increasing surpluses and deposited their petrodollars at money-center banks, which needed to be lent out. Similarly, the financial crisis pushed up the value of the dollar as the ultimate safe haven and reduced the yields on U.S. Treasury bonds, which are still seen by cautious investors as the best protection against a possible systemic collapse.
For Latin America, cheap and easy credit proved a trap. The good times came to an end abruptly, and a long 'lost decade' ensued. The crisis actually lasted from 1982 until the mid-1990s and was characterized by hyperinflation, debt default and currency disintegration.
Although inflation was accelerating throughout the 1970s because of government deficits and loose monetary policy, it was not thought to be a major concern. As long as wages were indexed to inflation, as they were in Brazil, government officials believed that no one would suffer.
"Actually," asserts Roett, "inflation is the worst enemy of the poor."
Savings were reduced to nothing and wage earners were forced to live from hand to mouth. Faced with the daily loss of value of money, not only the poor, but many in the middle class rushed out and bought anything they could just to get rid of their money. Those who still had money kept it on overnight deposit accounts, which paid extremely high interest rates, or shifted their assets abroad.
"At one point, we calculated that capital flight in Argentina was equal to its total debt," says Roett.
Government officials in Brazil in particular felt that they could defeat inflation relatively easily. Yet, it accelerated quite suddenly out of control, and once inflationary expectations took hold there was no stopping runaway price increases. In the United States, too, the chorus of advanced warnings is becoming loud. Former Fed Chairman Alan Greenspan suggested that unless monetary policy is tightened soon, inflation will rise to 10 percent, revisiting levels not seen since the early 1980s. Having presided not only over a period of easy credit in the United States but also over the cleanup of the financial mess in Latin America, Greenspan may be uniquely placed to know the consequences of loose money and runaway inflation.
Roett has recently co-authored a book for the Brookings Institution on China's expansion into the Western Hemisphere. It has passed the United States as Brazil's largest trading partner, even though Roett admits that it may be a temporary phenomenon, triggered by very high prices of commodities which Brazil sells to the Asian giant. Nevertheless, China's political influence is increasing as well. The two countries are starting to talk with one voice at international forums, and both have been discussing the emergence of a post-dollar world.
Roett acknowledges that the greenback is in no imminent danger of being junked as the world's reserve currency -- simply because there is no plausible replacement for it. Nevertheless, such talk can't help but undermine long-term confidence in the dollar. With trillions of dollars now held by world central banks, even a marginal shift out of the dollar could trigger a currency plunge. Once again, Roett has the Latin American experience to draw on. Brazil and Argentina have gone through a variety of currencies, which became useless almost as soon as they were introduced. The Mexican peso was eventually redenominated, losing three zeros.
The U.S. dollar is unlikely to share this fate, or join Brazil's forgotten cruzeiro and cruzado or Argentina's austral on the dust heap of monetary history. But those who ignore that history are doomed to repeat it.
Roett believes that financial stability was restored in Latin America when governments at long last began to follow the ten policy recommendations contained in the so-called Washington Consensus, which prescribed monetary and budget discipline as well as structural reform and greater transparency. There have been some variations, too. For example, Chile under Augusto Pinochet avoided most of the regional problems by bringing in monetarist economists of the Chicago School. But Venezuela, a number of Andean countries and Argentina under the current Peronist government are still making the same mistakes that got Latin America in trouble in the first place, says Roett.
For several decades, Brazil has been touted as the emerging United States. It had all the prerequisites to become an industrial giant, but misguided government policies undermined its economic potential. Now, when everyone has almost lost hope, the country seems to be getting its act together. It suffered only a mild downturn in the current global recession and is now growing once more. For the first time since World War II, it has even seen a reduction in its poverty rates.
On the other hand, Roett recalls that at a recent meeting of the Group of Twenty industrial and emerging nations Brazilian President Luiz Inacio Lula da Silva complained that much of the advice given by the United States to his country was ignored at home. He referred not only to debt-fueled monetary and fiscal profligacy but lack of structural reform and transparency.
Could it be that the United States is suddenly at risk of becoming the next Brazil?