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Latin America in danger as U.S.-China wage currency war

Posted by seumasach on October 27, 2010

International Business Times

26th October, 2010

Latin America may suffer severe consequences as global heavy-weights China and the U.S. wage their currency war.

The U.S. will fight this ongoing battle by flooding the world with trillions of newly-printed U.S. dollars. China can stubbornly resist by using capital controls to accumulate U.S. dollars and limit yuan appreciation.

For Latin America, this could be disastrous.

 

If they do nothing, their currencies will appreciate versus both the dollar and the yuan. However, fighting back to limit their currencies’ appreciation can be difficult. Latin American countries don’t have China’s tight grip on the flow of capital in and out of the country.Market intervention can be costly and fruitless, especially against China and the U.S.

Although a weaker dollar and capital inflow may be positive under normal circumstances for much of Latin America (especially commodity exporters), they can be quite dangerous in the post-crisis world and in the context of the global currency war.

 

The effect of the weaker dollar and yuan is twofold for many Latin American countries; it makes exporting commodities more lucrative while tradeable manufactured goods face steeper competition. If this condition is sustained for a long time, it could cripple or even wipe out tradeable goods sectors in some Latin America countries, said Mario Blejer, former Governor of Argentina’s central bank, and Eduardo Levy Yeyati, former chief economist of the same institution, in a Project Syndicate commentary.

 

For example, Mexico‘s currency, like those of other Latin American countries, appreciated against both the dollar and the yuan in the past 18 months.  This hurt Mexico ability to compete with Chinese exports in the U.S., by far its largest export market, said Blejer and Yeyati.

 

Then there is the massive inflow of capital caused by the Federal Reserve’s quantitative easing.  The excessive liquidity — which is difficult to manage and counteract for policy-makers — fuels asset bubbles, creates the illusion of wealth, and induces over-consumption.

 

These conditions set up Latin America for future crises similar to the recent U.S. financial crisis, except Latin America is less equipped than the U.S. to deal with such problems, said Blejer and Yeyati.

 

Moreover, the Fed may eventually tighten monetary policy, reverse the tide and pull capital back to the United States, which could disrupt Latin America’s financial systems and cause wide fluctuations in the currencies market.

 

Blejer and Yeyati said these countries have the right to defend themselves during the global currency war through unilateral foreign-exchange interventions and capital controls. However, they said Latin America should also try to foster regional policy coordination, which might enhance its bargaining power and more easily internalize the cost of spillovers from China and the U.S.

 

Email Hao Li in New York at hao.li@IBTimes.com.

 

 

 

 

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