Latin America’s Trump Problem

SANTIAGO – Donald Trump reached the White House by bringing out the worst in the United States’ electorate. Will his administration now bring on the worst – both economically and politically – for Latin Americans?

The initial signs are nothing if not ominous. Not since the days of gunboat diplomacy a century ago has a yanqui leader treated the countries south of the US border and their citizens so badly. Trump infamously branded Mexican migrants rapists and murderers. Guatemalans, Ecuadoreans, and Colombians, though not explicitly mentioned, did not feel particularly reassured.

With US participation in the 12-country Trans-Pacific Partnership (TPP) dead in the water, the next question is whether Trump will make good on his vow to renegotiate the rules governing the North American Free Trade Area, or even to pull out of NAFTA altogether. Trade agreements with Central America, Colombia, Chile, and Peru could also be at risk.

No one (perhaps not even Trump) knows what the new administration will do in this regard. A US president can renounce these pacts unilaterally. But the volumes and volumes of implementing legislation were enacted by Congress, and can be modified only by a congressional vote. The US economy (and businesses) would not benefit from an overnight and wholesale abandonment of the rules governing not only trade in goods and services, but also investment, intellectual property, and government procurement across much of the Western Hemisphere. The Republicans may no longer be the party of free trade, but it is hard to imagine a Republican-controlled Congress willingly jumping off that cliff.

For Mexico and the Caribbean basin, trade with the US is crucial. For the countries of South America, which trade as much or more with Asia – especially China – and the European Union, macroeconomics and finance are far more important.

The expectation of a surge in infrastructure spending in the US under Trump has caused a number of commodity prices to soar (overall uncertainty has also sent investors packing into metals such as gold and copper, which function as safe-haven assets). So, in the short run, mineral exporters like Peru and Chile are benefiting. But the run-up in prices may turn out to be short-lived, especially if Chinese growth continues to slow.

If Trump does half of what he has promised, cutting taxes on the rich and increasing defense and infrastructure spending, the US will run a much more expansionary fiscal policy. The resulting boost to aggregate demand would then buttress the case for the Federal Reserve to raise short-term interest rates faster than it had been planning to do. But, while such a change in the fiscal-monetary mix might be beneficial for the US in the short term, it would create new challenges for Latin America’s emerging economies.

Tighter money and a looser fiscal stance in the US almost surely would mean a stronger dollar. That is bad news for governments and companies south of the border. Yes, more prudent policies and better regulatory frameworks have allowed local-currency bond markets to flourish in recent years. But in Latin America, much of public and especially private debt remains dollar-denominated, which limits how much central banks can allow currencies to depreciate in response to higher US interest rates.

A decade ago, economists were optimistic that flexible exchange rates would allow emerging markets to insulate their economies from monetary-policy shocks coming from the developed countries. Floating is still the best alternative, but today the overall assessment is much less sanguine. Not only is such flexibility de facto limited by dollar debts; US monetary conditions, it seems, are transmitted to other countries quite independently of their exchange-rate regimes.

London Business School’s Hélène Rey has argued that US monetary-policy shocks affect risk premia, and that this channel operates internationally as well as domestically. This “risk-taking” channel of monetary policy is so powerful internationally that when the Fed loosens policy, credit grows all over the world, and vice versa. So if higher interest rates in the US went hand in hand with higher premia and a reduced appetite for risk among investors, Latin America could find itself under financial stress.

This brings us to the broader question: how will Trump affect perceptions of risk worldwide?

Larry Summers and other thoughtful observers have long argued that the US could use more investment in roads, bridges, and ports, and that at today’s record-low long-term interest rates, such investments would pay for themselves. Trump is adding to that recipe massive tax cuts for the wealthy. The much larger deficits and debts (add several portions of nationalist rhetoric and a generous helping of foreign-policy inexperience to the mix) could easily prompt a surge in risk aversion and a sizeable increase in long-term interest rates – which would undermine much of the rationale behind self-financing infrastructure investments.

No one wants to live in a more uncertain world – least of all people in the still-vulnerable countries of Central and South America. Those vulnerabilities are political as well as economic. Just when recent electoral results in Argentina, Peru, and Venezuela, coupled with term limits for incumbents in Bolivia and Ecuador, suggested that South America was reaching the end of a cycle of left-wing populism, the US – and much of Europe – seems to be entering a cycle of right-wing populism.

There is no shortage of Latin American demagogues who will likely try to emulate Trump’s campaign. The lesson will not be lost on them that no statement is so outrageous that the news media will not cover it, and that the benefits of increased attention outweigh the political costs of the outrage. Just as in the US and Europe, immigration – not from Muslim countries, but from neighboring states – could provide a convenient lightning rod. So could nationalism: there is a certain poetic symmetry at work when local left-wing activists complain about threats to national self-determination – just as Trump did – in arguing against the TPP and other trade agreements.

For Latin America, a return to the facile rhetoric and self-defeating policies of populism would be the most dangerous side effect of Trump’s victory. One can only hope that, during his presidency, Trump plays as fast and loose with his campaign promises as he did with the truth during the campaign.