Latin Finance - May 2008 - 56

michael pettis development. Both are growing in importance as a source of funding for corporations, although the Chinese investor base is still highly speculative and not particularly rational at allocating capital to its most productive use. How does it compare to Latin America? In terms of financial sophistication China is well behind a lot of Latin American countries, especially Mexico and Brazil, but its huge size and determination to reform and liberalize the financial markets means that it is an extremely interesting market in which to be. Once they fix the currency and liberalize capital flows it might even become a tempting place for Latin American borrowers, since local currency borrowing will provide some hedge for commodity exporters, who rely on strong demand from China to keep prices high. and all have very different histories and follow very different development models. One area, however, in which China was far ahead but is fast deteriorating to LatAm levels is in income inequality, and I think Chinese leaders are very worried about the political and social consequences. In that context Chinese economists and political commentators often talk with dread about the “Latinamericanization” of China. If China is able to address this problem successfully I think it might provide some very interesting lessons for Latin America. overextended banking systems, and so on. Ironically, all the building-up of reserves in order to avoid external debt crises has had a very worrisome domestic impact. It has required in many cases overly loose domestic monetary policies – China being exhibit A – and this has channeled risk into the domestic financial sector. The next set of developing-country financial crises will not be external debt crises; they will be domestic government debt and banking sector crises. What is the economic importance of China to LatAm, and vice-versa? From a business point of view there seems to be a great fit, but I worry about its long-term impact. China is a huge buyer of commodities and will be for the foreseeable future. In response to Chinese and other demand unfortunately Latin America seems to be reverting to the old days when it was largely a commodity exporter and little more. Maybe this time is different, but in the past the commodity-export role did not serve Latin America’s development needs very well. What are the main reasons for the differences? Mostly history, I think. Latin Americans have experienced modern financial markets pretty continuously for over the past 100-150 years, and even longer in some cases. It has only really been since the 1990s that China has sought to develop modern financial markets. I would also add that information disclosure, corporate governance, and stability in the regulatory and political framework are much weaker in China than in the major LatAm countries, whereas insider behavior and unpredictable government intervention are very common, so this has severely hampered the development of a balanced investor base, while encouraging speculative behavior. In China it is very difficult to be a fundamental investor – even Warren Buffet would be a speculator there. How is that likely to change over the next five years? Bad loans in good times: Pettis If we get a sharp, and probably necessary, adjustment in China there will probably be a slowdown and a sharp drop in commodity prices, but in the medium term I expect Chinese demand will stay robust, at least until it begins to suffer from its very difficult demographic challenge. Are LatAm and other emerging markets now crisis free? Absolutely not. I hear this a lot, and it is among the dumber things that I have heard. There is an assumption that because foreign currency reserves have risen so dramatically relative to external debt, the days of sovereign crises are all but over. This represents both a misunderstanding of why crises occur and what kinds of crises have happened in history. Financial crises are always caused by a balance sheet mismatch sufficiently destabilizing that the country is unable to withstand an adverse shock. Currency mismatches are simply one way that these can occur. There are many other ways – for example too much short-term local debt, To what extent are Chinese companies looking to acquire in LatAm? I think they are very eager to do so. There is a sense in China that it is imperative for national companies to secure access to commodities. I think also that as the country grows in strength and importance its business leaders are increasingly looking outside of China for business opportunities, and there are a number of ways in which it makes sense for Chinese businesses to operate in the region. What does LatAm need to do to catch up, and how long might that take? I am not sure LatAm needs to catch up, since several countries in the region are actually further ahead in many respects 56 LATINFINANCE May 2008

Latin Finance - May 2008

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