Financial Dependency and Growth cycles in Latin American Countries (Carlos Aguiar Medeiros)

CarlOS aguIar DE MEDEIrOSFinancial dependency and growth cycles in Latin American countries Abstract: This paper argues that there was a remarkable similarity in the external cycles in Latin America’s economic history. The desarrollo hacia fuera, the Economic Commission for Latin America and the Caribbean earlier designation for the World Bank’s “outward-oriented” model, that prevailed in the last part of the nineteenth century until 1930, was from the beginning a financial-export model where financial integration to the world economy played a central role. An orthodox economic policy based on fiscal contraction, a high rate of interest, and incentives to external debt in order to sustain convertibility and free capital flows was a permanent strategy of this model. After a long period distant from the world financial markets, many Latin American countries received throughout the 1970s and especially during the 1990s, huge volumes of financial capital that brought about once again a similar pattern and strategy of international integration. Key words: economic growth, exchange rate policy, external debt, trade specialization. The strength of the liberalizing reforms and orthodox economic strategy launched in latin american countries in the 1990s gave momentum to a macroeconomic dynamics and an outward economic model similar to the old pattern that brought these countries into the global economy in the nineteenth century. This occurred not solely because a reinvigorated primary export model was affirmed in many countries as a dominant economic leadership, but also because the evolution of the payments Carlos aguiar de Medeiros is a professor at Instituto de Economia/universidade Federal do rio de Janeiro. This paper is based on research done at the Faculty of Economics, Cambridge university, with financial support of CaPES (Coordenação de aperfeiçoamento de Pessoal de Nível Superior). The author thanks CaPES for the financial support and an anonymous referee for insightful remarks. Journal of Post Keynesian Economics / Fall 2008, Vol. 31, No. 1 79 © 2008 M.E. Sharpe, Inc. 0160–3477 / 2008 $9.50 + 0.00. DOI 10.2753/PKE0160-3477310104 80 JOURNAL OF POST KEYNESIAN ECONOMICS balance was shaped by financial flows. The old pre-Keynesian doctrine of sound finance and free capital flows was restored as a business and government quasi-consensus. The spectacular crisis of argentina in 2001 followed by a default in external debt and the nationalistic policy adopted in Venezuela in the past few years were a backlash of the radical financial opening that happened in the 1990s. These exceptions came in contrast to the prevailing policies in Brazil, Chile, Colombia, Mexico, and small countries in the region based on a strong reliance in high commodities prices and in policies aimed at attracting foreign funds. Financial dependency and economic growth The historically different patterns of financial and exchange systems between countries and regions brought the exchange rate regime to the core of development economics. For instance, Dooley et al. (2003) referred to asian countries as “countries of trade account” in contrast to latin american countries described as “countries of capital account.” The former exchange regime is typical, as argued by Mahon (1996) and also by the Trade and Development Report, 2003 (TDr), of a development strategy that favors trade and industry, whereas the latter favors essentially financial capital. These papers discuss the crucial difference between these two strategies and their predominance in asia and in latin american countries, respectively. However, the institutional and structural conditions that command each adoption are not evident. among structural factors, the composition of exports plays a central role. In latin american countries, commodities have historically had a significant weight in total exports. The different income elasticity between exports and imports and the great volatility of commodities prices in the international market have generated cyclical variations in the import capacity and high instability in exchange rate and demand for capital flows.1 (2003), in an empirical paper covering the previous 20 years, found higher appreciation in the real exchange rate (rEr) associated with capital inflows in latin america than in asian countries. He suggests that the composition of capital inflows where foreign direct investment (FDI) and exports are a large part of capital flows and the evolution of nominal wages explain the relative stability of rEr in asian countries. The dominant role of capital flows directed to exploit the domestic market and the evolution of nominal wages in latin american countries was associated with major price increases and higher appreciation in rEr. 1 athukorala the economy has to adjust its rate of growth or its export and import elasticities through depreciation in real exchange rate (hereafter rEr) and tariff policies. The classical formulation of the two gaps model was developed by Chenery and Bruno (1962). One of the failures of such an argument is that it does not recognize that latin american countries have always been more open to foreign capital than asian countries.4 This model assumes that capital flows are a real necessity. there is another factor that has an autonomous dimension and. In fact. for example.FINANCIAL DEPENDENCY AND GROWTh CYCLES 81 Chronic deficits in current account historically present in latin american countries were associated with trade specialization that gave birth to a “foreign exchange gap”2 as a central feature of developing economies. as far as CaD grows. 3 The World Bank and mainstream economics consider latin american countries closed to international trade and inward oriented. To exploit this argument. external indebtedness can be excessive and not explained by current account problems. but as the economic history of latin american countries abundantly shows. where R stands for variations 2 The “foreign exchange gap” emerges as an extension of the Harrod–Domar model for open economies of the third world. by the external debt (and assets) stock upon exports—possess an autonomous explanation rather than merely being a consequence of the kind of trade specialization. plays a structural role: the historically high level of external indebtedness of latin american countries. Because there is a limit to financing CaD. In addition to the savings gap—a common version associated with this model—this version considers a foreign exchange gap that holds whenever a low import capacity hinders the increase of investment rate until the level allowed by savings availability is reached. Dropping [I]. which are described as more open and outside oriented. 4 See Calvo (1998) for analysis of this binding constraint. the high levels of indebtedness— measured. This second kind of gap is impossible in the neoclassical approach. see Serrano and Souza (2000). in opposition to asian countries. But in addition to the specialization of commodities. which says that proper macroeconomic policies always enable internal resources to become foreign exchange. where FCA stands for net capital account and CAD stands for a current account deficit. there is a necessity of higher capital inflows that respond for a disequilibrium between the potential rate of growth and the availability of currency. it becomes [II] FCA = CAD + R + NRCO. due to its persistence. This difference on the role of external finance has deep implications that are the object of reflection of this paper. consider a developing economy that has a deficit in its trade current account. eliminating the gap. For a broad discussion. . So it is possible to equate [I] FCA = CAD.3 The problem of the “foreign exchange gap” model is to assume that indebtedness is always economically needed. 2003) and is associated with many historical and political aspects. there is no difference if the foreign liability is a foreign bank loan or a bond placed in international market. this imposition is only part of the story.82 JOURNAL OF POST KEYNESIAN ECONOMICS in reserves and NRCO stands for the nonregistered capital outflow that can be considered a proxy of the standard classification of the balanceof-payment errors and omissions. Devlin. Knapp examined the problem of excessive borrowing. and the liquidity preferences (for strong currencies) of the wealth owners of these countries. This aspect has been referred to as “original sin” (Hausmann and Panizza. actually. there is an excess of financial flows over real necessity.” Besides. The crucial point observed by Knapp is that the reasons to contract a foreign loan are not necessarily entangled by a necessity to finance a supply of services and goods required for economic growth. The first deals with a loan-pushing process. the reasons for an excessive accumulation of claims for foreign currency rely on the combination of two different mechanisms. . 1989). 6 For the present discussion. and as long as they generate large outflows of nonregistered capital. The point here is the recognition that there is a financial demand for currency—a “liquidity preference for holding currency”—that does not arise by real necessity but by “financial fragility. these flows are financing a demand of residents to put their asset abroad.5 an overlending of foreign loans (or foreign-denominated liabilities)6 becomes an excess of borrowing when it compromises the external sol5 The idea behind the “original sin” is that the large ratio of foreign money– denominated debt on national debt is imposed by international capital markets. In developing countries. it derives from differential rate of interests. underdevelopment in financial system in borrowing countries. The other is the fiscal and internal credit self-restriction assumed by peripheral countries in order to fulfill the game rules of an international monetary system in a financially open and integrated economy. governments and firms decide to contract excessive loans or issue assets denominated on foreign currency. if this demand is supplied by a large flow of funds. In “Capital Exports and growth” (1957). as long as the growth of capital liability over capital asset (net of reserves) exceeds the current account deficit. the appreciation of exchange rate can generate an expansion of current account deficit that absorbs the currency surplus. However. 1988. The second mechanism is the excess of borrowing that depends on internal decisions. a whole set of pressures from banks and the governments of rich countries that exert in determined moments (when there is a low rate of interest and excess of liquidity in the dominant currency) a strong push in bank loan or finance bonds to peripheral countries (Darity and Horn. the availability of currency allows higher growth. (2006) for an open economy. It occurs through the rate of interest set by the central bank. or more flexible but stable exchange rate) could not be sustained. given the currency board system that characterized the argentinean exchange system during the 1920s (and during the 1990s as well). . the existence of a net financial inflow allows a rate of investment and a rate of economic growth higher than the profit rate. This expansion generated trade deficit. In an earlier interpretation on the argentinean cycle. Domar (1950) was right when he considered the solvency ratio as the ratio between the rate of exports and the rate of interest prevailing for the sovereign debt. according to this literature.8 The interaction of these two movements—loan push and overborrowing—can bring about a financial fragility trajectory. The increasing macroeconomic financial fragility (measured by the solvency ratio and liquidity ratio) arouses growing suspicion that the prevailing exchange regime (fixed. the volume of reserves at short notice vis-à-vis the volume of short-term debt provides a meaningful index of fragility. as mentioned above. which tends to increase as far as the income growth exceeds the rate that equilibrates the balance of payment. although these explanations depict correctly a trajectory of increasing financial fragility.FINANCIAL DEPENDENCY AND GROWTh CYCLES 83 vency and liquidity increasing the fragility of the peripheral financial system. an 7 although some models such as Moreno-Brid (1998–99) depicted the limits of growth with external debt in a convergent interpretation. This trajectory was examined by Minsky (1982) in a closed economy—an evolution from a hedge to a Ponzi finance—and was explored by Foley (2003) and lopez et al. most of them use the ratio between the deficit in current account and product. and there is no necessary link between an overlending and a higher rate of investment and income growth. The excess of import and the decline of foreign investment depressed the internal credit and economic growth until a new external cycle began. the increases on export prices and on foreign investment—both governed by forces outside the country—set in place an increase of internal credit and of imports that adjusted to the new offer of currency. peg. 8 See Medeiros and Serrano (2006). But.7 By its turn. in a constrained economy. Prebisch (1939) developed a compatible analysis considering that. That can be misleading. This generates a growing CaD and speculative regime. it keeps the idea that financial flows is governed mainly by the demand side and that overborrowing (considering the country solvency) has financed a higher rate of economic growth. p. such as considered by Prebisch. Thus. . the economic dominant pressures in an indebted country are for an overvalued currency. given the hierarchy of currencies in a financially open world. depending on the effects on the wage rate. stimulating government and firms. In other exchange regimes. there is a tendency for the domestic currency to depreciate. But the surge in CaD is associated with this rate of exchange demands and a higher rate of interest and a speculative and Ponzi finance. a surge in FCa brings about (through credit expansion) a strong expansion on CaD and. . Thus. the intrinsic fragility of third-world currencies as a safe means of holding wealth is always confirmed by the final direction of capital account movements. there is a chronic tendency for capital to move away from these currencies. the monetary policy can sterilize part of this monetary expansion through a higher rate of interest and expansion of reserves. in a financially deregulated world. the appreciation of rEr has a positive effect on economic growth through the increase of real wages and the reduction of the domestic cost of external debt. foreign debts may not be repayable. this is improbable due to disruptive capital flight (NrCO). This tendency cannot consistently be eliminated by monetary policy. except for exporters. the link between these questions and the nature of the tradable sector in latin america is based on three facts: (1) that the financial cycle makes the . as Patnaik (2002) affirmed. and that the domestic currency will depreciated against the dollar” (2002. The interactions of financial flows and exchange rate in peripheral countries depend on some institutional and structural dimensions. generating a higher CaD through an increase in profits and interest transferences. In a currency board regime with nonsterilized intervention. This is also valid for foreign investors in nontradable goods. this can cause a suspicion that the currency is not sustainable. and therefore. Nevertheless. Once again. according to Patnaik. it causes an increase in nontradable goods. generating an appreciation in rEr. MacKinnon affirmed that peripheral monies are only provisional because any “economic or political disturbance at home provokes the suspicion that . In a similar analysis. This results in a higher demand for FCa to finance a surge in NrCO. It is important to consider that in both regimes. The exchange collapse is the likely outcome of this trajectory unless successful exchange depreciation or intense decline in internal absorption equilibrates CaD. 2).84 JOURNAL OF POST KEYNESIAN ECONOMICS autonomous process from the creditors’ banks and from demanders of currency due to wealth motives can generate a speculative trajectory without any correspondence in the real world. The rest of this paper argues that the dominance of external events shaping the latin america financial cycles is a long-run feature. De long et al. It is important to observe that neither the surge in inflows nor the outflows are primarily determined by domestic forces but are made by the monetary policy of the “definitive money. (2004) related about financial flows—when it rains. (1998. the financial dependence is simultaneously a cause and consequence of this trade insertion in the world economy. She argues that in every technological revolution. Devlin (1989). let alone in the global economy—the capital flows to peripheral countries are looking for extraordinary financial opportunities. 1890. and low wages. When the bubble is over (following an increase in the rate of interest).10 In 1870. Kozul-Wright (2006). interrupting the financial frenzy in the beginning of industrial revolution or in the last phase of the maturity of an old paradigm. financial capital tends to concentrate in industrial countries. and during the maturity phase of an industrial revolution when the decline in economies of scale in the old economy triggers a speculative capital outflow and intense competition in order to keep the profitability. Eichengreen et al.” Here it is important to consider some characteristic of a financial cycle as depicted by Perez (2002). and TDr (2003) are good examples. as Table 1 shows. (1999). and (3) the import propensity is not compatible to the exporter base. (2) the overvalued exchange rate sustains activity levels. 10 9 .9 Therefore. all international cycles in latin american economic history were accompanied by financial inflows that shaped the internal cycle and liquidity crisis. 1999). These movements are stimulated by financial innovations and a low rate of interest. there are two moments when the “marriage” of financial capital and productive capital is broken: soon after the surge of an industrial revolution when a financial frenzy tries to enlarge the higher profit achieved in new activities through speculative bubbles.FINANCIAL DEPENDENCY AND GROWTh CYCLES 85 commodities prices cycle deeper. like Kaminsky et al. Financial cycles in Latin America There are a great number of historical and empirical papers exploring the similarities and differences between the present financial globalization and the nineteenth-century financial globalization. she considers that in these two phases—which in some cases can overlap because the industrial cycle does not occur simultaneously in all industrial countries. Nayar (2006). although Perez centers her arguments on industrial countries. it pours. good export prices. including Brazil. Defaults in Ottoman empire and in Latin American countries. financial transference for the continent remained negative or very low until 1970.86 Table 1 Financial cycles in Latin American economies Reversion Economic contraction in England and industrial countries. Capital inflows propitiated convertibility in currency board’s regimes. banks in Latin American market. Upswing cycle Main trigger factor 1860–76 maturity phase of railways era Low British rate of interest and acute competition among European banks for financing railroads in Latin American countries. During the war reversal in financial transference and import substitution. rate of interest and strong competition of U.S. Summary Financial cycle led by railway investment and refinancing of old debt. Reduction in U. JOURNAL OF POST KEYNESIAN ECONOMICS 1885–90 frenzy phase of steel and electricity era Low British rate of interest and speculative flows to mortgages mainly in Argentina and Uruguay. Collapse of terms of trade and defaults on debt throughout the 1930s. Reversal in terms of trade. World War I 1921–29 frenzy phase of oil and automobile era Dollar diplomacy. 1904–14 maturity phase of steel and electricity era Low British rate of interest and strong competition of European banks for Latin American loans for speculative and FDI purposes. . Collapse of Barings Bank. 1929 international crisis. The Barings crisis generated a strong contagious effect to many Latin American countries. After 1930.S. Finance loans to railways and ports. Strong valorization of terms of trade after the war. High levels of external borrowings for refinancing loans and public works. rate of interest. rate of interest in 2001 and 2002 and high valorization of terms of trade. 1991–2001 frenzy phase of information and telecommunication era Reduction in U. Strong elevation of U.S. (Between 1974 and 1981. collapse in terms of trade and Mexican default in 1982. some particular features in latin america based on Marichal (1989). Collapse in RER at the end of decade.S. A pure financial cycle with deteriorated terms of trade. data on TDr (2003). FINANCIAL DEPENDENCY AND GROWTh CYCLES Sources: Technological and financial phases based on Perez (2002). booming in export value was achieved by high commodity prices and high volume demanded by international trade growth led by the United States. After 1982.) Elevation of U. strong devaluations in RER caused hyperinflation episodes. Overborrowing in 1978–81 and different growth strategies occurred within countries with different trade and exchange rates regimes. exhaustion of mass privatization and high external financial fragility. the cumulative net inflows in [2000] dollars amounted $1. After devaluations in RER. ? 2002– Reduction in U.155 billion.1973–81 maturity phase of oil and automobile era Reduction in U. rate of interest in 1979. rate of interest in 1999–2000. rate of interest and extraordinary expansion of international “oil-dollars” loans. net inflows of $1.S. Overborrowing and strong valorization of RER.S. Brady’s Securitization of Foreign Debt and extraordinary expansion of liquidity (between 1992 and 2001. Radical profinance strategies. 87 .S.243 billion). and 1990.88 JOURNAL OF POST KEYNESIAN ECONOMICS 1920. a current account deficit not checked by exchange rate devaluation. generating contraction and defaults. and in many episodes. the supply of financial flows (loans and bonds) led by financial cycles in developed countries. The majority of loans were taken by the public sector through bond issuing in london mainly to refinance old debts and to finance railways. and changes in the rate of interest in the world financial centers brought about massive loans and capital inflows to latin american countries. The collapse of the exchange rate was followed by the impossibility to meet all of the debt compromises in foreign exchange. The incompatibility of this endeavor with the volatility of its exports generated a succession of exchange crises when long periods of exchange appreciation sustained by capital inflows brought external crisis and collapse in the rEr. the close integration of European merchant/banks and the production of raw material/food in the continent set in motion a new model of economic growth led by exports and financial expansion. after the independence. finance innovations. . Property transferences. But. and empowerment of mobile international asset holders have been some common political and economic outcomes of this pattern. denationalization. a profinance and procommodity strategy associated with these flows has stimulated an internationalization of private domestic assets. These financial inflows created a situation of loan frenzy to public and private sectors in latin american countries.11 But not only were these necessities financed by 11 For details and empirical evidence. a loan spree took place in the 1870s geared by high profit opportunities of commodity exports. In the export age. as was recalled by Marichal (1989). These cycles resulted in strong variability in the rEr with a tendency to depreciate against the strongest currencies. 1970. (1999). see De long et al. The finance-export age Prebisch (1949) showed that the inner dynamic of capital flows during the period toward hacia fuera (or export led) in latin american countries was connected to the building of the commodity infrastructure and export capacity for those countries. latin american countries tried to follow the gold pattern’s rule creating formal or informal convertibility schemes and restrictive Treasury policies. This cycle has been normally reverted by changes in the role of financial capital in industrial countries followed by external shocks transmitted through an increase in the rate of interest of a major financial center and by a fall of commodity prices. the Bank of England raised its discount rate. in 1889. the contraction of a big loan in sterling or the selling of bonds with gold clauses were the basis for credit and fiscal expansion and to sustain the convertibility of domestic currencies. When. the sharp reduction of capital inflows after the Barings crisis caused a balance-of-payment crisis. . This brought a huge devaluation in the exchange rate breaking with the gold standard clausal introduced in 1889. the financial crisis was settled.FINANCIAL DEPENDENCY AND GROWTh CYCLES 89 external capital. following a financial frenzy associated with a new technological wave led by the united States and germany (Perez. The capital flight that succeeded this large devaluation pressed the rate of exchange additionally with great effects in the inflation rate. and the next ten years were dedicated to renegotiation of debt with internal policies of deflation asset privatizations and nationalization of debts. 2002). this financial frenzy changed the property of infrastructure. Schemes of currency boards were introduced in many countries in the beginning of the century. With the collapse of the international system during the World War I. In consequence. In Brazil. The near-collapse of Barings Bank—by far the most specialized in argentinean finance—in 1890 and the argentinean default reached the entire continent.12 It is interesting to note that before 1929. During the second half of the 1880s. at this time. but their incompatibility with the sharp fluctuations of commodities prices caused systematic crisis. after World War I. the loans flows were stopped. The encilhamento crisis that took place in 1890–91 was a direct consequence of argentinean contagion. latin american countries practiced a more pragmatic monetary policy. This high volume of flows backed a large issue of golden pesos and gold bonds. argentina and uruguay attracted the majority of flows to finance railways and urban infrastructure. mainly in the form of foreign direct investment (FDI) took place. this was in order to follow the “game rules” associated with the monetary system led by England. a speculative issue of mortgage bonds created a huge expansion of wealth assets in pounds and gold for the rich elite of Buenos aires and Montevideo. In argentina. and under the influence of international missions 12 The most common analysis of this crisis attributes the inflation pressures and speculative frenzy to the fiscal imbalances created by excessive money issuing. So. a highly indebted country. there were no central banks in the region. For a review of this debate and data. see Triner (2001). many public works were also financed abroad due to the chronic credit constraint imposed by the policymakers. a second boom of capital flows to latin american countries. 1991). Dominican republic. merchants. The Brazilian economic policy based on the currency board of 1926–30 was a good example of this endeavor. as discussed in the next section. Venezuela. severe damages in the economy until the burst of a new cycle. Costa rica. in his early analysis of the argentinean external cycle (Magarinos. after the 1930s. Prebisch. an “autonomous policy” was launched in many countries as far as they decided to break with convertibility and to devalue the exchange rate. latin america started to face a new reality—scarcity of dollars. and politicians who formed the nucleus of the dominant classes of the primary export model were the main domestic group benefited.13 The scarcity of dollars ended only in the 1970s. 1970). This was the main reason for creating a central bank—as happened in argentina in 1935—with discretionary power on the exchange market and to issue nonconvertible Treasury notes. the wealthy land owner. many central banks were created. The basic line was to follow a more efficient orthodox policy based on “rules of the game” of the gold system and to attract new loans attending the huge financial transfers abroad. in many episodes. El Salvador. when the financial transferences became positive and excessive. in all speculative capital inflows. .90 JOURNAL OF POST KEYNESIAN ECONOMICS stimulated by growing concerns with capacity of latin american countries to pay their international debts. The experience of argentina deserves further consideration. and Honduras remained attached to a dollar exchange standard with little exchange or financial control. Cuba. argued that this system only worked during capital inflows and never functioned during gold outflow. bankers. the scarcity of dollars was a prominent factor. as argued by Marichal (1989). a currency board system aimed to give convertibility to the national currency. But this new political economy was confined to the big economies because these structural and institutional changes did not happen in small and passive economies. Nicaragua. 1996). When the argentinean Central Bank was created and ruled by raul Prebisch. 13 It is important to consider that although during these years. They were supposed to control the discretionary power of the Treasury (Furtado. urban property owners. guatemala. Ecuador. It was the most developed country of latin america during this period until 1935. Haiti. latin american countries never interrupted drastically the placement of assets abroad (Mahon. But the persistence on keeping this system caused. Panama. reflecting structural and political aspects. the great differentials in the rate of interest brought about by the reduction of the u. the most important innovation was the floating rate loans that passed the risk to the borrower (Devlin. uruguay. During the 1970s. With these financial innovations. in argentina. Nevertheless. there was not a large previous debt to finance. differently than in this financial cycle. prime rate in 1971 opened opportunities for international banks—led by u. In Brazil and Colombia.FINANCIAL DEPENDENCY AND GROWTh CYCLES 91 Debt-led growth in the 1970s The surge in capital flows in the 1970s is remarkably different compared to the flows of the 1920s. 1988). the Sovereign Immunities act of 1976. Capital controls were never adopted in Mexico and in small countries as in the former countries. the capital account was much more controlled in countries such as Brazil and Colombia. banks in euromarkets—to place the excess of funds in developing countries.S. courts (Darity and Horn. a sharp financial liberalization occurred. What seems however similar to the 1920s was the overlending and overborrowing process. But in the 1970s. removed the doctrine of absolute sovereign immunity from u. exchange regimes in latin american countries were very different.S. In Mexico and Venezuela. So before the export or import substitution proceeds were available—where the foreign resources were used to promote . Besides that. and the deregulation of the financial system. a great part of the new loans was to cover old loans given the short maturity that still prevailed in the majority of this loan spree. Different from the previous periods (and the 1990s). Shifting from bond finance and from direct investment toward bank finance was the main financial change. This change was built by the enormous dollar liquidity generated by the explosion of oil prices. the excess of liquidity gave birth (at the end of the decade) to a stabilization strategy based on a fixed exchange rate. In argentina and Chile. a fundamental financial innovation that pushed the huge volume of surplus funds from the eurodollar market to peripheral countries was the possibility of bank lenders to form large-scale syndication and the inauguration of cross-default clauses in loan contracts. In addition. the maturity of the prevailing technological paradigm. as in the nineteenth century. Independent of the reasons—in Brazil. capital inflows were used to launch a heavy industry plan—the external indebtedness had its own dynamic. the huge increases in oil prices were followed by real appreciation of domestic currencies.S. 1989). on its turn. a crawling peg system avoided a real appreciation in exchange rate. and Chile in the last years of the decade. high inflation. in what has been known as the “first Washington consensus. as shown by the estimated data of capital flight. but only after the Mexican debt rescheduling in 1989 was it implemented in the indebted latin american countries. The . despite the differences in the use of foreign currency. The main solution for the unbearable latin american debt was political. the FCa was in large excess of the necessities put by the variation of CaD. enlarging its external liability (Devlin. financing positive variations in r and NrCO. This marked a radical move from what was christened the “ancient regime” of imports substitution. The external crisis was the base for radical reforms in latin american countries. as in Venezuela. led by u. Higher domestic interest rates. It was started as a political and economic problem after the Malvinas (Falklands) War.S. 1989). as previously considered. This shift in capital flows—net capital autonomous inflows became strongly negative—occurred in all countries except Chile. Venezuela. Capital flight reached large volumes until the end of decade (Schneider. 1987).). 2003). although the numbers were not comparable with those that prevailed in the 1980s.” was to launch a new pattern of economic growth led by private enterprise through a comprehensive integration to world markets. and high incentives to contract external loans created an overborrowing process that assumed in many places. in argentina in 1988 and in Brazil in 1989. Except in Chile (which attracted more political support) and Colombia (with lower debt). The 1990 external cycle and the return of the “treasury view” The 1980s were characterized by huge capital outflow. Treasury Secretary Nicholas Brady. the most regulated country (Cumby and levich. the same “millions fever” as observed by Furtado (1982). argentina. On average. significant capital flight took place in Mexico. significant capital flows were repatriated (ibid. debt services above exports reached 40 percent and the foreign currency reserves expanded in the continent through short-term financial resources. and even Brazil. The objective. in the last years of the 1970s. and stagnation.92 JOURNAL OF POST KEYNESIAN ECONOMICS exports or import substitution—the borrower country had to cover debt services with new loans. The huge increase in the interest rate in 1979 and the banks’ decisions to cut lending to latin american countries after Mexico’s default in 1982 interrupted this cycle and imposed strong currency devaluations to finance the transfers for the creditors’ banks. all stabilization efforts failed. But the real expectation was to attract the capital flows from foreigners and repatriate the stock of dollars held by residents. lower exchange rates. It is important to note that since the 1980s. the International Monetary Fund (IMF) had a stronger involvement in latin american countries.” the Central Bank and the Treasury. Dismantling capital controls was the dominant aspect to launch a profinance strategy in latin american countries (TDr. the new function of underwriting bond issues that spread throughout the decade dissipated the bank risks by selling off participation in latin american loans (Darity and Horn. In a similar role played by the banks during the 1920s.” a secondary market in commercial bank loans for latin american countries’ debts established to “relieve u. Trade and capital account liberalization. but to establish a new model of economic development centered on trade and financial integration. the “technopols. In this strategy. 2002).S. p. These flows were preceded by the rise of “Brady’s bonds. reflecting the renewed power of the interests of banks. 2003). This was considered a huge opportunity not only to stabilize the economy and defeat it from high inflation (hyperinflation in argentina and Brazil).S. By the same reason. 2003. as in all previous cycles. export-oriented business. Eichengreen and Bordo. The great financial innovation was the dominant role of the huge american pension and mutual funds on capital markets. 36).FINANCIAL DEPENDENCY AND GROWTh CYCLES 93 1990s brought to latin american countries enormous inflows of capital attracted by high interest rates and huge privatization opportunities. But the novelty throughout the 1990s was the growing submission of the latin american central banks to the IMF stabilization package . banks of non-performing loans” (TDr. the decline in the u. deregulation. 1988. assumed a high leverage over the economy. and the owners of dollarized assets. But the new role of the Central Bank was created by a strong connection with the IMF. providing funds for financial rescues in loans with high policy conditionality. and mass privatization spread to the continent. the IMF acted more as a representative of creditor banks than as a public multilateral finance institution for countries seeking assistance. as became clear in the Mexican crisis of 1994. Its leverage in the region was proportional to the external debt to be restructured and financed. interest rate in the beginning of the 1990s and the financial innovation (securitization) that followed the financial frenzy associated with a new technological wave (telecommunications and information technologies) started a new external cycle.” But at the same time—and different from the nineteenth century—it gave a more political meaning to the liquidity crisis in that it involved millions of american pensioners. This movement gave fund managers and investment banks a great leverage on financial markets and a final say on “investor confidence. In consequence. the combination of external indebtedness with denationalization of wealth (dollar-denominated financial assets and securities held by residents and domestic financial and securities assets held by nonresidents) reached no precedent levels since . Brazil. in that sense. this submission was the result of a growing external instability demanding growing IMF intervention. there was an overborrowing process and. alternating phases of huge inflows of capital and appreciation in rEr succeeded by the collapse in exchange regime and capital flight. Different from the 1970s and more similar to the 1920s. this profinance strategy resulted in a very short boom–bust cycle. the cosmopolitan national groups changed the composition of their assets enlarging financial deposits in foreign banks. Throughout the 1990s. First. and Mexico. This high level of inflows financed. as in argentina and Brazil. and squeezed public spending. in part. domestic debt boomed. there was a practical consensus between the “technopols” and academic economists that the best policy to be followed by the Central Bank was the policy prescribed by the IMF. but. Second. banks. 2003) show that capital flight was a permanent feature and after 1994 reached high levels in the region. the available data (Schneider. led exclusively by the monetary policy. by its turn. a high rate of interest was the main policy and the issue of public bonds indexed to the dollar was the main instrument. as in the old pattern that prevailed before the 1930s or in the 1970s. In order to control the outflow pressures and attract new capital. In many countries. a huge deficit in current accounts was set in motion in the majority of latin american countries by the combination of trade liberalization and appreciation in the rEr. both resulting in liquidity abundance. their interests were more in common with the international creditors and investors.94 JOURNAL OF POST KEYNESIAN ECONOMICS centered on deflation policies. the FDI played a major role and was attracted essentially to privatization deals in public utilities. the new inflows created their own demand in the form of imports of goods and services. In part. In all latin american major countries. and industry in countries such as argentina. after its inception in the early 1990s. due to its effects on the rEr enhanced by an adverse terms of trade. high volumes of capital flight. mainly investment. many deflationary policies deepened the policies and goals above the target established with the IMF. The financial transferences toward the region became largely positive covering a great deficit in current account and attended to the national residents’ high domestic demand of dollar-denominated assets. this submission was the result of two other processes. ” as put by Eichengreen et al.FINANCIAL DEPENDENCY AND GROWTh CYCLES 95 1930. the reversal in capital flows generated a collapse in the exchange rate followed by a financial and asset crisis (Brazil in 1998. Nicaragua. Bolivia. but the decline of this rate after 1994 allowed the financial cycle until the end of the decade. interest rate in the beginning of the decade started this financial cycle. Ecuador. and uruguay in 2001–2). In other countries. (2003).14 Two processes were developed. like in other financial cycles. The provisional nature of latin american currencies was never as evident as in this decade. the external and domestic interest rates were of utmost importance. The terrorist attack in the united States launched a strong military expansionist policy with a decrease in the rate of interest. The decline of the u. or Brazil. Peru. it was started by external forces. improving their solvency and liquidity ratios for a higher 14 Here the standard notion of dollarization is considered as the deposits in dollars by national residents. For a detailed analysis of the dollarization process including other concepts and the high index reached in latin america. as was observed in other historic episodes. federal funds rate in 1994 precipitated a capital reversal in Mexico. the deposits in dollars and the share of loans denominated in dollars displaced completely the domestic monies from these functions. (1999). the “last financial crisis of the nineteenth century. uruguay. a short increase in the u. Despite that. argentina in 2001–2. In countries such as argentina. capital flight outnumbered by far the amount registered in the 1980s. Chile. at the same time. and Costa rica.S. see reinhart et al. China launched an anticycle policy with big effects on asian countries and on the commodities market. . Both events affected trade volume and commodities prices of the main exports of the region. although the domestic monies were not replaced. as in other external cycles. This strongly enlarged the income terms of trade of latin american countries and shifted its negative current account. Venezuela. the 1990s crisis showed that increases in the rate of interest were never enough to stop the capital outflow when the rate of exchange was perceived as strongly overvalued. a depreciated rEr achieved in the beginning of the twenty-first century by the majority of the economies could not start alone a new external cycle nor reverted rapidly the trade account that became in a few years largely positive. the share of offshore deposits as a share of total deposits increased strongly. From the mid-1990s. such as Mexico. The rate of interest was very high in nondollarized latin american counties (mainly in Brazil) in order to stimulate the capital inflows. In fact.S. many latin american countries in this decade and—after the collapse of the 1980s—the majority of the countries during the 1990s. EClaC’s early designation for the World Bank’s “outwardoriented” model. Due to external innovations in the money market (bond or loan finance) and the prevalence of low interest rates in developed countries. was from the beginning a financial-export model where the financial integration to the world economy played a central role. . The external cycle in the continent showed some common features. The high propensity of the domestic cosmopolitan classes to keep assets in dollars and their political leverage on economic policy comes from this kind of financial integration. The chronic trade unbalances historically associated with latin american countries in contrast with asian countries cannot explain the high reliance on external finance. jeopardizes the diversification of exports. the excess of external finance created its own demand through current account deficits. The appreciation of exchange rate is once more a common feature in many countries and precludes them from seizing this extraordinary opportunity to diversify exports to sectors less dependent on natural resources. that prevailed in the last part of the nineteenth century until 1930. strong inflows of foreign capital were attracted by profitable opportunities in financially open latin american countries. by its turn. In many episodes presented in this paper. The desarrollo hacia fuera. This new commodities-oriented cycle brought new opportunities for different national strategies—seized after a huge crisis of argentina and Venezuela. However. an orthodox economic policy based on fiscal contraction.96 JOURNAL OF POST KEYNESIAN ECONOMICS growth despite the negative transference. followed a similar pattern and strategy of international integration. and incentives to external debt in order to sustain convertibility and free capital flows was a permanent strategy of this model. after a long period distant from the world financial markets that lasted until 1970. a high rate of interest. the majority of latin american countries took the same strategy based on fiscal discipline and openness to financial markets. The impact of this financial integration on trade is transmitted through a high variability in rEr that. Despite the huge demand for strong currency for wealth purposes. Conclusion This paper argued that there was a remarkable similarity in the external cycles in latin american countries’ economic history. 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