Argentine Malaise May Be Contagious

Argentina, its economy collapsing, is about to drop out of the world economy, taking with it $132 billion in debts to international banks and governments, sizable investments from U.S. and European companies and probably the hopes of a common market uniting all the economies of South, Central and North America.

Yet financial markets don’t expect an Argentine bankruptcy to have a major effect on the U.S. or other Latin American economies. And the Bush administration is reacting coolly to raging troubles in a country that only yesterday the U.S. held up as a model of free-market policies. “Once Argentina has an economic plan, we will be supportive,” a U.S. Treasury spokeswoman said last week.

But such confidence may be mistaken because Argentina is unlikely to go quietly. Default on its debts will cause losses for U.S. and European banks, says Walter Molano of BCP Co., a Greenwich, Conn., investment partnership that focuses on Latin America. FleetBoston Financial Corp., the largest bank in New England, holds $21 billion in Argentine loans, for example.

U.S. companies that have invested in Argentina, from Metropolitan Life Insurance Co., which owns pension management companies, to Liberty Media Corp., which owns cable systems, will see the value of their holdings reduced by a likely devaluation of the Argentine peso, which has been pegged at one peso to the dollar for the last decade.

Argentina’s troubles will discourage lenders to and investors in Brazil and other Latin countries. Brazil needs $25 billion a year in foreign investment, experts say, and won’t be able to get that much, so it could be the next trouble spot in Latin America.

Mexico, on the other hand, will be less affected by Argentina’s collapse because it now is linked to the U.S. economy through the North American Free Trade Agreement, says Geoffrey Dennis, Latin American equities manager at Salomon Smith Barney.

However, the 34-nation Free Trade Area for the Americas that President Bush proposed at the summit of Western Hemisphere leaders in April appears dead--at least for a while.

The FTAA already was in trouble, says Philip Potter, a Washington lobbyist, because the Bush administration angered key members of Congress in deals made to get fast-track trade authority in December. And the administration angered trading partners by keeping out Brazilian oranges to appease Florida citrus producers.

With Argentina now about to retreat from free-trade policies, the hemispheric vision must await a better day.

What lies ahead? Argentina will renegotiate its loans and won’t be able to borrow abroad for a few years, so its economy will be poor and discouraging to small and medium-size businesses. The government will print money to pay its people, who have been rioting in the streets because the government bars them from withdrawing their bank deposits.

Devaluing the currency will make Argentina’s exports of beef and grain more attractive to the world, while making imports too expensive for Argentine consumers with reduced purchasing power. The country of 37 million people with annual economic output of about $300 billion--3% of the U.S. total, 38% of Brazil’s--will go into hibernation.

A rest period away from the pressures of the global economy could ease tensions in Argentina, a country that has known unrest for more than 50 years, first under Juan Peron and his wife Eva, who turned workers against the middle classes, and then under a murderous military dictatorship.

The last decade, with economic policies that pegged the peso to the U.S. dollar, saw rising prosperity for a while. But then Argentina’s weak economy failed to adapt to changed world circumstances after the Asian and Russian financial crises in 1997 and ’98 and it again went into decline.

Many of Argentina’s wounds are self-inflicted, economists say. Due to laws reflecting the country’s Peronist tradition, employers must pay workers social and pension benefits that are 50% higher than those of other Latin countries.

Argentina’s agriculture and industry have not been innovative with “more sophisticated products,” but have stuck to exporting basic commodities such as grain and meat, which are subject to price competition, notes economist Manual Pastor of UC Santa Cruz.

Yet Argentina is not alone in having inflexible labor laws, commodity products and repeated troubles--think of Brazil’s crises and those of Peru, Venezuela and others.

Latin American economies never seem to advance very far, in contrast to those of the European Union, which in recent decades has raised the economic levels of poorer nations and regions such as southern Italy, Ireland, Portugal and Spain--the latter two now major investors in their historic South American colonies.

Why has Europe succeeded and the Western Hemisphere failed? “Institutions,” says Sebastian Edwards, an expert on Latin America at UCLA’s Anderson School. “Strong institutions and fiscal prudence are key” for economic success, Edwards says. The poor nations of Europe had to adopt the EU’s strong institutions--balanced budgets, low inflation.

But Argentina’s institutions, its civil service and judiciary are weak. And though Argentina tied its currency to the dollar to try to control its traditional inflation, it did not adopt strong U.S. laws on budgeting and credit.

Latin America can do better. Mexico is improving institutions steadily, and ultimately all the hemisphere’s countries will have to do so if the FTAA vision is to become reality.

Meanwhile, the scenario for Argentina’s immediate future can be either pessimistic or optimistic, says Jennifer Jimenez, manager of emerging-market funds for Montgomery Asset Management in San Francisco. Pessimistic would be “if Argentina goes back to indexing wages and brings back the inflation of the 1980s,” Jimenez says.

But the optimistic scenario for a country that, after all, has a large, educated and skilled middle class population, is “a devaluation of 25% when all the turmoil settles down,” Jimenez says. Then, she sees Argentina returning to better credit standing and fuller participation in the world economy in “18 to 24 months.”

In the meantime, Argentina’s collapse will engender furious debates and denunciations about globalization, the International Monetary Fund and the rich nations and the poor.

Will we cheer or cry for Argentina?

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Times staff writer Chris Kraul in Buenos Aires contributed to this column.

James Flanigan can be reached at jim.flanigan@latimes.com