Dear reader, I promised yesterday that i was going to update this text that I wrote with Brad Setser in 2006. However, I just came home and really have no time to do anything else. So, here it goes the second part of the text (the first I published yesterday). The main conclusion that seemed valid in 2006 that Latin countries didn´t belong to the Bretton Woods II regime is no longer valid. For a variety of reasons I think Latin countries do belong to BWII. The sistem is however deemed to be changed so a new Bretton Woods will emerge (with the end of this financial crisis) and Latin countries will play a decisive role in the new engine. It will no longer be only China and the US but new players like Brazil will be in the new Bretton Woods system. For now, enjoy this piece. Vitoria
The rise in Latin America international reserves is relevant because of the fast pace it has been happening and also because it has not been followed by an increase in short-term debt, as illustrated in the figure below.
Latin America: Short-term debt and International Reserves
While there is no consensus on the amount of international reserves a country can hold as a way to prevent an eventual ‘sudden stop’ we follow Summers’ (2006) to that end. He explains that a good approximation to such an end is the so-called Guidotti-Greenspan rule, the idea that a healthy level of reserves is enough to cover all foreign debt coming due in one year. In the absence of any rollover, the difference between international reserves and the one year short term debt is what is shown in the next figure and coined ‘excess reserves beyond short-term debt’.
Latin America: Excess Reserves Beyond Short-Term Debt
Latin America and Asia: Excess Reserves Beyond Short-Term Debt
Apparently, the above figure suggests that Latin American countries are holding reserves in excess of any precautionary motives. Summers (2006) provides strong arguments – in line with Rodrick (2005) on the cost/benefit analysis – to explain that at least a share of the excess reserves held by ‘developing’ would be more efficiently used in the country in areas like health, education that lack government endowments. In any case, the above figure resembles the ongoing status of the BWII countries. Can we then say that Latin America is in the early stages of BWII? In other words, is it fair to say that Latam countries have, in different degrees, the features discussed in the previous section that are in the core of the BWII system? In what follows we propose a preliminary comparison between BWII countries and the Latam ones.
2.1 Similarities between Bretton Woods II and Latin America
There are three relevant aspects in common between Asia and the oil export countries (core of the BWII system) and Latin America.
First, most countries in Latin America are not free floaters in their FX markets. Similar to the BWII countries South American countries also engage in intervention in their foreign exchange markets. In different degrees, both regions implement sterilized intervention as an important tool to reduce exchange rate volatility and hence accumulate international reserves. In the figure below, setting Brazil aside, it is possible to notice a relative stability in the real exchange, especially after 2003.
Latin America: Real Exchange Rate (2003 =100)
A second similar aspect between the regions is related to change in the current account as a share of GDP. According to the figure below, we observe that the increase in the current account surplus affected Latam, Korea and China in 2003 as compared to 2002. Another interesting finding is that Korea decreased its current account to GDP ratio in 2005 whereas Latam displayed a stable value as compared to 2004.
Yearly Change in the Current Account as a % of GDP
A third and related similarity between the regions is the rate of increase in net international reserves. From 2004 to 2005, Latam net international reserves as a share of GDP went from 9% in 2004 to 11% in 2005 and China from 32% to 35% in the same period. Clearly, the increase in exports in all the Latin American countries and in China was an important factor to explain the improvement in the current account.
China and Latin America: Net International Reserves as a % of GDP
Interesting enough is to observe a similar pace of convergence between China and Latin America, especially with respect to rate of increase in the current account. In 2001, China’s current account was equal to 1.3% of GDP, a value close to the one registered by Latin America in 2005 (1.6% of GDP).
China and Latin America: Current Account as a % of GDP
Latin America and Korea posted small current account surplus in 2005, equal to 2% of GDP. The amount of reserves held by Korea is almost three times larger than Latin America in 2005. However, the 2005 figure for net international reserves as a % of GDP in 2005 in Latin America resembles the one posted by Korea in 1999.
Korea and Latin America: Net International Reserves as a % of GDP
Korea and Latin America: Current Account as a % of GDP
After the 1997 crisis, Asian countries started to implement policies of reserve accumulation as a way to prevent sudden stops in the future. Though one cannot say with certainty what amount of NIR would avoid sudden stops, the reserve accumulation policy never stopped in Asia. It seems that Latin American countries are accumulating reserves for precautionary reasons, in a pattern similar to the one displayed in Asia from 1998 through 2000.