The emerging-market crisis will roll on, mutating like a virus as it kills investor dreams. Sure, Latin America's flaws are not those of Asia. But they're deep enough for the region to get whacked.
When the Asian crisis first struck, many investors in Europe drew a line under the global emerging-market crisis and continued to pour money into Latin America. "Latin America is different," they said.
It's true the region didn't suffer from a surfeit of cheap foreign capital or from overinvestment, as Asia did. And the aftermath of Latin America's 1980s hyperinflation had left the region with a bank-credit-to-GDP ratio of under 40% compared with Asia's average 120%. What's more, the bankers (and some corporate managers) I regularly meet in Brazil and Argentina are world class. The same cannot be said for their Asian peers.
So, if Latin America suffers few of Asia's excesses, there will be no Latin American crisis - right? Wrong. Latin America will not have an Asian-style crisis. The virus of crisis is too smart for that. That's why all those predictions based on the last crisis are just rear-view mirrors that tell you why the next crisis will be different.
What will eventually undo Latin America will be a modified form of the Asian crisis. It will happen like this. Latin America's debt burdens are external rather than internal (as in Asia). External debt is still enormous in relation to exports (150% to 300%) and debt-service ratios are 35% to 55% compared with Asia's 10% to 15%. That's because Latin American economies have never pursued an Asian-style growth-through-exports strategy.
When it comes to growth, the existence of big external liabilities means that Latin America has to run to stand still. It needs foreign capital to finance economic expansion and restructuring. And then it needs more of it to service the debt burdens of history.
There are no secrets about how to get this money. Either there has to be a big trade surplus, which means an excess of domestic saving over investment. Or global liquidity has to remain abundant enough and domestic returns high enough to attract capital to finance Latin America's double deficits on current account and public finances.
This is where things are going to go wrong. The emerging-market crisis is a global one that will continue to deepen, unfold and then engulf more countries for a long time yet.
There are three drivers behind the continuing crisis. First, Asian central banks will soon have to ease interest rates and inflate their way out of their domestic debt burdens. That will trigger a new round of devaluations in emerging-market currencies.
Second, growthless China will have to devalue the renminbi. When it does, there will be a big crisis in Hong Kong. That matters more than 10 Indonesian-style collapses.
Third, the IMF and its allies may throw more money at Russia. But it's a country where government is incapable of achieving fiscal equilibrium and whose people will find and absorb all the dollars that flow in. So Russia will blow out too, though a quick and costly fix might work for a short while.
When the next outbreak of the emerging-market crisis occurs, Latin America will suffer a dearth of external financing. That will leave it with a tough choice. The first approach would be to allow domestic liquidity to dry up and asset and labour prices to deflate, which is what Brazil's and Argentina's currency pegs to the US dollar would imply. Alternatively these countries must cut the exchange-rate link and devalue to boost trade, while printing money to avoid deflation.
The transmission mechanism - from pressure on the currency to domestic deflation - will be made worse in such countries as Brazil and Argentina by the huge growth of domestic money supply relative to forex reserves. Once international reserves start to drop, that monetary multiplier goes into reverse.
The fundamental weakness of the Latin American economies is their savings and investment ratios. I'm not going to trot out the old shibboleth about virtuous Asia's 30% to 40% of GDP savings and investment ratios as the mantra of all economic success. No, it is the gap between the savings and investment ratios, not the absolute level, that determines the external financing requirement of a country before servicing its stock of external debt.
Mexico, Brazil and Argentina have excessive and worsening net external financing requirements of 5% to 6% of GDP because their domestic saving levels cover, on average, only 85% of investment capital requirements. Moreover, Latin America's inadequate savings ratios are down to government, as much as to households and corporates. And the fiscal picture in such countries as Brazil, which will run a budget deficit near 8% of GDP this year, won't change without a crisis.
When the crisis comes, Brazil, Argentina and Mexico will be faced with a choice of sudden fiscal contraction and tight monetary policy to sustain the exchange rate, or to cut and run. Argentina will keep its dollar peg but pay the price in high interest rates and low growth. Brazil will devalue after a fight. Mexico will let the peso go. But the region won't escape the Asian contagion.
David Roche is president of Independent Strategy, a London-based research firm.