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How the Global Financial System Is Hobbling South America’s Response to COVID-19

Argentina’s public health response to COVID-19 was far better than Jair Bolsonaro’s disastrous mismanagement in Brazil. Yet as the two countries seek to rebuild, both are enfeebled by their subordinate place in the global financial system, a subordination that is threatening to turn today’s shock into a protracted crisis.

The front of the Central Bank of Argentina. (Ricardo Ceppi / Getty Images)

In the past few weeks, both Argentina and Brazil have hit the headlines — but for very different reasons. Argentina is praised for its early lockdown which, at over ninety days so far, is currently the longest in the world, and for its relatively low number of deaths and cases (1,043 and 44,931 respectively to date).

Brazil, in contrast, drew attention because of President Jair Bolsonaro’s dangerous dismissal of the pandemic, which he termed a “little flu.” His response has been swamped in chaos: his sacking of the health minister was followed in less than a month by the resignation of his successor, while he has also publicly fought governors who imposed a lockdown, and openly attacked democratic institutions by calling for a military intervention in Congress and the Supreme Court.

Indeed, Brazil is in the midst of a political crisis, and the total number of deaths and cases, currently at 51,271 and 1,106,470 respectively, is still rising steeply — making the entire region the premier COVID-19 hot spot. Even the official figures are now in question, with Bolsonaro ordering that case numbers should no longer be reported and data erased from the official site.

Despite these striking differences, the two South American countries are each likely to face dire external economic consequences as a result of the global pandemic, on top of their many shared domestic problems. The United Nations Economic Commission for Latin America and the Caribbean (ECLAC) estimates a significant contraction of these economies for 2020: 6.5 percent for Argentina and 5.2 percent for Brazil.

The reason why Argentina and Brazil took very different approaches to the public health crisis, yet will face similar external economic problems, lies in the common role they play in the international division of labor. In a nutshell, the two countries are producers of agrarian and mining commodities for the world market, and have a subordinated financial insertion into the global financial system.

The COVID-19 crisis reduced the inflow of ground rent and caused an outflow of foreign capital from the region, worsening already existing problems. A global public health crisis has again exposed the weaknesses of capitalist development in South America, posing the need for deep structural changes.

While the current proposals coming from progressives both from the region and abroad focus on providing necessary relief in short order, understanding the structural roots of Argentina’s and Brazil’s current economic problems will allow us to see the need for a much deeper political, economic, and social transformation.

Role in the World Market

The role of Argentina and Brazil in the international division of labor has historically been to act as worldwide suppliers of cheap agrarian and mining commodities for the world market. This is mostly because favorable natural conditions (fertility, rain patterns, and temperature, among others) allow these countries to produce food and raw materials more productively and with lower costs per unit.

Given that the price of agrarian and mining commodities is set by the land with the lowest productivity (otherwise the price will not suffice to keep it in production and there will be unsatisfied solvent demand), the extra productivity of labor in Argentine and Brazilian lands becomes an additional amount of profit, which takes the form of ground rent.

Therefore, when Argentina and Brazil sell these commodities in the world market, their commercial prices carry a flow of ground rent toward these countries. At first, ground rent goes into the pockets of landowners — a class that, from the point of view of the valorization process, is nothing more than a social parasite. That is, it does not participate in any way in the production process yet still extracts a portion of the value created on it.

However, different mechanisms allow a direct (i.e., through the mediation of the nation-state) or indirect redistribution of this ground rent toward industrial capitals and workers. For example, export taxes allow the state to capture some of the ground rent from landowners and direct it toward industrial capitals through subsidies, and toward workers through social programs, among other means.

As a result, the expansion of ground rent allows capital accumulation in Argentina and Brazil to grow beyond the limits imposed by the restricted productive capacity of the heterogeneous and low-productive local industrial capitals (mostly small capitals that lagged technologically behind, and managed to survive by compensating their lower rate of profit through paying low wages and appropriating ground rent); whereas a relative decline of ground rent inflows means the stagnation or contraction of these economies.

In other words, a greater influx of ground rent provides an impulse to produce, which propels a demand for labor, and thus, growth in wages; whereas, when ground rent stagnates or contracts, the opposite happens.

Given that ground rent flows are inherently unstable, these countries experience sharp economic and political cycles. The history of Argentina and Brazil appears thus as a pendulum that swings from periods of growth embodied by center-left populist governments that adopt some degree of pro-working-class policies, to periods of contraction personified by neoliberal ones that openly attack the working class.

Collapsed Trade

Given the role Argentina and Brazil play in global capitalist accumulation, it becomes easier to understand the effect of the coronavirus pandemic on their economies. For the most important impact of the crisis is the contraction of the inflow of ground rent. This appears first as a deterioration of external trade, affecting Argentina and Brazil both due to the fall in prices as well as the shrinkage of external demand.

Most of the commodities that constitute Argentina’s and Brazil’s main exports have fallen in price since the start of 2020. According to the central banks of both countries, from the beginning of the year, the price of the raw materials most important to Argentina fell 14 percent by May (7 percent lower than the same time last year), and those relevant to Brazil fell more than 3 percent from January to April (although they were still 3 percent higher than the same period last year).

When it comes to external demand, ECLAC estimates a contraction of 6 percent in the volume of regional exports. The fall of exports to China is estimated to be much larger (a decrease in value of 24.4 percent), and will have an important impact in Argentina and Brazil due to China’s importance as a commercial partner. In particular, it will reduce the purchases of iron, copper, zinc, aluminum, soybeans, and soybean oil.

Additionally, the fall in Chinese demand due to the COVID-19 crisis will affect the exports of intermediate inputs and with it, industrial production. The United Nations Conference on Trade and Development (UNCTAD) projected that Brazil could lose $84 billion a year given a 2 percent reduction in China’s exports of intermediate inputs, particularly affecting the automotive and metals sectors — two important activities for the Brazilian (and also Argentine) economy. Manufacturing already showed important drops of production in these two countries in March, compared to the same month of the previous year.

All things considered, ECLAC estimates that the value of exports in the region will fall at least 17.6 percent in South America as a whole and 15.1 percent in Brazil.

The fall in trade will mean a significant contraction in the inflow of ground rent to these countries, and therefore in the capacity of the state to appropriate and redistribute it, which is likely to continue in the months to come. In turn, this will constrain Argentina’s and Brazil’s resources to implement countercyclical policies at the scale seen in developed economies.

Subordinate Financial Insertion

The subordinated position of Argentina and Brazil in international financial markets is the other side of the coin of their role in global production. Their subordination finds an expression, first of all, in the difficulties they face to acquire US dollars or loanable capital denominated in that currency to engage in world trade (including importing necessary means of consumption and production), not to mention storing value. At some point, the need to acquire dollars exceeds their capacity to produce or borrow them leading to a limit on their growth, which is typically known as the “external restriction.”

The original trade impact of coronavirus is likely to be worsened by the subordinated financial position of the South American countries, which has already led to capital flight and a stop of external financing, further creating dollar shortages. UNCTAD estimates that the cumulative net nonresident portfolio capital (i.e., mostly short-term foreign investment in capital markets equity and debt) outflows from Brazil have been the largest in the world in January and February, even though it considered only equity while for the other countries debt is also included. In March and April, the country was surpassed by India and Indonesia, but the outflows kept increasing, reaching more than $12 billion per month. However, in late May there was an incipient return of external flows to the country when Brazil issued five- and ten-year bonds at lower rates of interest than expected.

For Latin America as a whole, ECLAC estimates that not only will there be a reduction in capital inflows to the region ($80 billion less compared to 2019), but there is also going to be an outflow of capitals from the region. Additionally, UNCTAD estimates that the region will experience the largest drop of foreign direct investment flows, with a reduction of between 40 and 55 percent.

As a result, exchange rates in Argentina and Brazil have already suffered intense pressure and have lost value significantly. Since January, the Brazilian real has depreciated by 33 percent (although it fell by 48 percent by mid-May, before it started to recover). The fall was so precipitated, that until early April the real was the third hardest-hit currency in the world after those of South Africa and Mexico. On the other hand, the Argentinean peso has depreciated by 15 percent, although the informal exchange rate has depreciated by 61 percent.

Given that the overvaluation of the exchange rate is the main indirect mechanism of ground rent appropriation for both Argentina and Brazil, a devaluation will further limit the amount that could be distributed to industrial capitals and workers. In a nutshell, this is because a devaluation raises the price of exports (a rise that goes into landowners’ pockets) while increasing the price of imports. More expensive imports raise costs for domestic industrial capitals that buy means of production abroad. They also push up the prices of consumer goods (many of them not domestically produced) for workers, lowering their real wages.

To contain the depreciation of their currencies, the central banks of Argentina and Brazil had to sell US dollars, leading to an accelerated loss of international reserves. From March 10 to the end of May, Argentina has lost $2.2 billion, while Brazil has lost $21.9 billion (around 5 and 6 percent of their total reserves at the beginning of the period, respectively), although Brazil recovered from its lowest point in early May.

Repaying Debts

In turn, the loss of reserves will affect the two countries in several ways. One problem will be repaying their external debt. This problem is particularly acute in Argentina, which is currently carrying out a debt renegotiation process that could lead to the country’s ninth sovereign debt default. The Argentinean external debt is mostly in the hands of the central government and stands at 73.6 percent of its GDP. This level is largely the result of the huge inflow of external debt during Mauricio Macri’s administration, which gave a fictitious boost to the scale of accumulation. In this situation, acquiring more external debt as a source of financing is almost off the table for Argentina.

In Brazil, nonfinancial corporations hold a much larger share of external debt, which could lead to bankruptcies if there is no access to US dollars. For example, the state-owned oil company Petrobras is the world’s most indebted oil company, and given the collapse in oil prices will probably face severe difficulties.

In this context, acquiring foreign currency has already become more expansive for South American countries. The cost of borrowing for Argentina and Brazil has skyrocketed since the beginning of March. The Emerging Markets Bond Index (EMBI), which shows the spread between interest rates of dollar-denominated bonds and US Treasury Bills (T-Bills), more than doubled in the couple of weeks that went from the beginning of March to the end of April. Since then it has recovered, but it is still significantly higher than pre-COVID-19 levels. The ICE BofA Emerging Markets Corporate Plus Index showed a similar increase.

Moreover, the large withdrawal of foreign investors from emerging markets has been particularly acute in equities, adding fuel to the fire in domestic stock markets. In Brazil, the fall was so precipitated that circuit breakers were triggered to avoid further losses six times in eight days. In this country, the trend had already started in 2019, when foreign investors pulled a net R$15.2 billion ($3.7 billion) out of the country’s stock markets.

Conflicts Ahead

As the threat of a balance of payments crisis has become more pressing for both countries, several proposals have been floated on how to confront the situation — typically proposals suggest increasing the provision of dollars. It is striking that these debates are not as heavily focused on the national economy itself as they used to be. Rather, the international character of the coronavirus crisis has forced both right- and left-wing economists to take into consideration the global nature of capitalism and the need for solutions at that level.

Right-wing economists and politicians — both from South America and abroad — are advocating policies that mostly fall into three categories.

First, an extension of currency swap lines by the Federal Reserve, something that has been already announced for Brazil (providing up to $60 billion for at least six months), following an experiment previously conducted after the 2008 crisis. Similarly, the Fed started a repo lending facility with foreign central banks, including the Argentinean Central Bank, to loan dollars using T-Bills as collateral.

Second, increases in International Monetary Fund (IMF) and World Bank loans or grants to countries in need, and some cancelation of debts owed to them.

Third, the issuance of IMF’s Special Drawing Rights (SDR). All of these policies address (partially) the short-term dollar needs of the countries in the region. However, they do not challenge the current international monetary system and offer no structural change to global finance.

In contrast, progressive economists are typically calling for three different types of policies. First, they demand the lifting of US economic sanctions. These do not affect Argentina or Brazil, but they certainly impact other Latin American countries, such as Cuba and Venezuela. Second, they call for increases in capital controls. Finally, they demand cancelation of unfair debts and the provision of help to countries that seek to restructure their external commitments.

These policies also address the dollar needs of South American countries, while challenging to some degree the current international financial system. There is no doubt that they would be an integral part of any strategy to provide necessary relief to the region in short order. However, they are not an answer to the region’s structural problems insofar as they leave unchallenged the productive structure and financial position of these countries in the world economy.

As we have seen, the critical economic situation faced by Argentina and Brazil is a result of their role as worldwide suppliers of agrarian and mining commodities, and their subordinated insertion into the global financial system. Their international position was greatly worsened by COVID-19, leading to major economic difficulties. As long as policy proposals only provide short-term relief without radically transforming the international division of labor and the global financial system, the problems of both Argentina and Brazil will persist.

Rather than relying on old formulas, this moment requires left-wing economists to think critically and boldly — providing radical solutions for what are structural problems.