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Free Market Losing Ground in Latin America

Latin America has never been a bastion of the free market.

But in the 1990s, several countries – most notably Chile and Argentina – bought into the “Washington consensus” that free markets provide the best chance to move up the global pecking order.

Unfortunately, that belief has been steadily squashed over the last decade following Argentina’s 2001-2002 default.

Now the free market is in retreat all across Latin America, and new leadership is coming to power.

Here’s what this means for you…

The Mexican elections showed unexpected gains for the hard left forces. A new wealth tax in Colombia has darkened that country’s prospects. Venezuela descends further into chaos. And Brazil is struggling with a worsening recession and Argentina’s economy continues to shrink.

Change of the Mexican Guard

In the midterm elections last week, all three major parties lost ground.

President Enrique Peña Nieto appeared to retreat from his reforms in the run-up to the election held last week. He suspended his plans for testing the nation’s teachers, an essential reform of Mexico’s poor and union-dominated public school system.

Nieto’s government maintained its majority, but the far left led by Andrés Manuel López Obrador gained some ground. On the bright side for the current government, Pemex announced the discovery of five new offshore oil blocks, suggesting that, in at least one area, Peña Nieto’s reforms may be having some effect.

But, if the Mexican economy is still sluggish when the next Presidential election rolls around in 2018, the chance that López Obrador could win will be substantial.

This would lead to big change in Mexico as López Obrador seems likely to follow the socialist anti-market road of Hugo Chavez and Argentina’s Cristina Fernandez de Kirchner.

Light and Dark Side of a Republic

Speaking of… Venezuela demonstrates what can happen when a left populist wins election in a country with substantial natural resources.

Admittedly, Hugo Chavez was extremely lucky. Oil prices, which bottomed out the year he was elected, climbed steadily to 10 times their previous level over the next 15 years, allowing him to spend money like water and appear to be a popular hero.

He achieved re-election fairly easily several times until his death in early 2013. In the two years since, his successor Nicolás Maduro has pushed the socialization of the economy ever further, and has seen it slip into an inflationary slump.

The chances of Venezuela rejoining the international economy and achieving even part of the prosperity that its natural resources should make possible aren’t good, currently.

Brazil, on the other hand, appears to have become locked into a cycle of expanding government.

President Dilma Rousseff, who was re-elected last year, installed a finance minister who proposed a budget with a modest primary surplus (before debt interest). But Brazil doesn’t look likely to achieve this.

You see, Brazil’s economy is sinking deeper into recession, while the central bank, extraordinarily, has pushed up interest rates to 13.75% – more than 5% above the rate of inflation.

Thus, while Brazil’s fiscal policy follows the dismal precedent of perpetual budget deficits set by the major Western economies, its monetary policy has bravely embarked in an entirely different direction.

Regrettably, it seems unlikely that Paul Volcker’s monetary policies will provide anything other than an ever-deeper recession without proper budget discipline. This seems unlikely as Rousseff recently proposed yet another pharaonic infrastructure spending plan.

Freedom Losing Its Grip

Even the apparent free market successes in Latin America have been backsliding recently.

Chile’s President Michelle Bachelet has instated a big tax increase, and the economy’s rapid growth has slowed as commodity prices have declined. Colombia was last year’s star as it grew rapidly and re-elected President José Santos.

But in December the country took a sharp swerve left with a wealth tax. This month the tax zapped Bancolombia (CIB) with an additional tax liability that wiped out its substantial increase in operating profit and produced a decline in net income.

Colombia’s decision is extraordinary. The country wasn’t in any great budget difficulty, though the decline in oil prices had stretched the projected 2015 deficit. And the wealth tax, which is at a rate of 1.5% annually above $2 million, when added to income tax and the ravages of moderate inflation, will make it very difficult for Colombians to earn a real return on their savings.

In the case of Bancolombia, the new tax is also a massive incentive towards higher leverage, which is hardly a direction the banking system should be taking in these uncertain times.

One can sympathize with Latin America, though. Countries highly dependent on commodity exports find their fortunes far more linked to the commodity price cycle than to any strengths or weaknesses in their policy approach.

Pacific Basin countries seem to be overcoming the difficulties of being an emerging market in a world destabilized by the West’s eccentric monetary policy. But Latin American countries aren’t.

Until things change, that fact should determine where we put most of our investment money.

Good investing,

Martin Hutchinson