The first thing I do when I write this is read what I wrote last time, largely to see how correct (or not) I was. My parting words in the July issue were to warn of the vulnerabilities of being too exposed to China and especially via commodities, which left the Chilean peso particularly out on a limb. I don’t pretend to have foreseen the extent that the world subsequently became concerned and correlated to events in China, but it’s worth looking more closely at this theme because it’s going to remain very pertinent.
To varying degrees, Latin America has been no different to many other economies, especially developed ones, who have chosen to orientate themselves towards the China growth story. During the period when China possessed a voracious appetite for investment and related commodities, Chile, Brazil and also Venezuela saw a substantial increase in the share of China in their total exports, standing at around 25% for Chile (predominantly copper) and 20% for Brazil (oil but also shifting towards softs). Naturally, they were not the only ones to tread this path, with Australia benefitting greatly from China’s commodity consumption boom.
The thing that stands out is that Australia was early in realising the vulnerability of over reliance on China. Probably more than two years ago I noted that the Aussie was trading less like a commodity currency, with its correlation to global commodity prices declining as it orientated its economy more towards domestic demand. Australia also had the ‘luxury’ of an easing cycle which instigated a weaker currency to help it on its way. For most Latin American countries orientated towards China, the options have been a lot more limited. Brazil has been coping with its own demons in its domestic economy and has been raising rates over the past year to (so far unsuccessfully) curtail surging inflation. Meanwhile, Chile saw its economy grind to a halt in the second quarter, to a large degree as a result of the fall in the copper price. But with rates already low and inflation rising, the central bank finds itself in something of a policy bind as a result. There is not an easy way out, especially for Chile, because it’s the most exposed both via commodity prices but also China’s re-orientation away from the type of investment that previously boosted demand for it. Both the real and peso will underperform their peers into year end.