Part I

As China’s development model evolves from manufacturing and export-based growth to services and expansion of its enormous domestic market, its economic and political relationship with Latin America is rapidly undergoing profound transformations.

Brazil is China’s largest trading partner among Latin American nations

China’s targets in this regard have been outlined in several meetings, like the special forum held in 2015 between China and CELAC[1], where China announced the objective of raising its investment flows to Latin America to $250 billion in a decade, while increasing its annual trade with that region to $500 billion in the same period.

But clearly, the windfall gains that Latin American countries[2] obtained from record high prices for their commodity exports are over, and the consequences have been serious economic crises and deep recessions.

A commodity boom that went sour

Trade between China and Latin America exploded since the turn of the millennium as the share of sales to China of Latin America’s total exports grew from 2% in 2000 to 10% in 2015. Imports from China grew faster, also from 2% to 17% in the same period, clearly leading to growing trade deficits, which were made up by large loans and investments from China, mainly in infrastructure and developing new sources of raw materials.

In this way, China became the second or third largest trading partner of most countries in Latin America, and by 2015, the economically largest nations in the region (Brazil, Mexico, Argentina, Colombia, Chile, Peru and Ecuador, accounting for almost 90% of its GDP) exported close to $90 billion to China and imported almost $160 billion, 78% more, according to the IMF.

Brazil, the largest nation in the continental American landmass and the biggest economy in Latin America, is China’s largest trading partner with two-way trade of more than $80 billion in 2015, but Brazil’s total trade which China only represents around 3.3% of its GDP, clear evidence of the enduring closedness of the Brazilian economy.

Nevertheless, Brazil has been mired with a devastating recession since the fall in the prize of commodities, resulting from China’s less robust demand for them, and the following collapse of its term-of-trade, which will wipe out more than 10% of its GDP before it is over.

One of my distinguished professors at the University of Chicago, currently at UCLA, asked me once how it is possible that the Chinese economy that is still growing at a much faster pace than any other major country in the world could generate such devastating effects on its commodities’ providers like Brazil.

There are several answers to this question. First, plans were drawn in commodity producing nations to keep expanding supply at the incredibly fast rates that China’s demands kept until its slowdown.

Second, the changing pattern of China’s development de-emphasizing building infrastructure and housing, represented a swift reduction in demand for commodities associated with construction.

Third, governments always consider temporary windfall gains resulting from very positive terms-of-trade as permanent, and they raise their public spending and debt accordingly, leaving them totally unprepared to abrupt collapses in the prices of their main exports, as in this case.

This explains not only Brazil’s tragic economic and financial meltdown but also a good part of its ongoing political troubles.

However, trade-wise Chile’s dependence on China is much higher than Brazil’s, and in fact it is the highest in Latin America. Last year, Chile sent 25% of its exports to China (7.2% of its GDP) and imported from China a bit more than one-fifth of its total purchases abroad (5.5% of GDP).

Nonetheless, Chile’s economic situation is far better than Brazil’s because for the most part, its economic policies have been quite prudent despite the protracted but to a large extent failed attempts of sitting President Michelle Bachelet to adopt more populist policies.

Lavish lending, a serious miscalculation?

There is an essential part of China’s strategic approach to South America – Mexico, and most of Central America and the Caribbean are a different story also in this regard – that the Asian giant might come to regret: its large and generous lending policies.

In the past five years, China has lent close to $70 billion mostly to nations that will not be able to pay back, like Venezuela which is on the verge of blowing up politically and economically, and Argentina that under new management is undoing most of the populist policies of the last 12 years of the Kirchner/Fernandez couple, including a strategic alliance with China, adopted in exchange of loans of significant amounts, which will be carefully reviewed by the new administration of President Mauricio Macri.

Brazil is in a different situation altogether but might have trouble keeping current on its obligations with China, which amount to hundreds of billions of dollars in a thick maze of project financing, direct loans and advance payments for future deliveries of commodities.

This could be the case if the Brazilian economy continues to implode, inflation remains high, and the credit-rating agencies keep downgrading the country, whose ample international reserves are not sufficient to cover all external public and private indebtedness, which, in turn, might lead to a currency mismatch, capital flight and a run on the real, Brazil’s currency.

Another potentially losing relationship China has in Latin America is with Cuba. At the demise of the Soviet Union, of which Cuba was an economic and political puppet, an intense and secretive relationship developed between China and the Caribbean island-nation, two of the few remaining Communist-managed regimes, although the Chinese economy was rapidly becoming capitalist.

With the end of Venezuela as the largest benefactor of Cuba, and the trade and investment embargo by the U.S. very much in place, since it is mandated by Congress despite President Barack Obama’s effort to circumvent it by restoring diplomatic relations by executive order, the Cubans will demand more financial involvement by China, very much in the give-away terms that they have received so far. The capacity of Cuba to pay back is so far non-existent.

China-Mexico ties: Thorny and different

As we have mentioned in previous columns, Mexico’s relationship with China has grown enormously, but in a radically different way from the rest of Latin America, because of three salient factors.

First, Mexico, for the most part, is not a major exporter of raw materials that barely represent 15% of its total sales abroad, thus the impact of the collapse of commodities prices is far less devastating than in the rest of the region.

Second, since China joined the WTO, a keen competition developed between both countries for a larger share of the U.S. market.

Third, an enormously asymmetrical bilateral relationship has evolved between China and Mexico, where the import/export balance of the latter is 11-to-1, leading to a trade deficit in excess of $65 billion last year.

Chinese loans and project finance operations in Mexico are minimal, a situation that was not helped by cancellations of major projects in rail transportation and a huge Dragon Mart mega-mall venture, dubbed “the largest venue for selling Chinese goods in the Western Hemisphere.”

This means the rapprochement of Mexican President Enrique Peña Nieto’s (2012-18) administration toward China has been put on hold and postponed indefinitely.

Many Mexicans believe that China does not trade fairly or subsidize their exports. They also believe that there is State-sponsored smuggling of merchandise, first exported to the U.S., then shipped in trucks to Mexico and while on-route, workers change the labels of the products to put the brand “made in the USA,” thus entering the country without paying duties, as if they were NAFTA (North American Free Trade Agreement) products.

I have heard endless stories of Mexican clothing and textile manufacturers who claim that they have irrefutable evidence of the widespread use of this practice. And then there are the never ending accounts of China sending illegal chemical precursors to produce methamphetamine in large amounts for the insatiable U.S. market for this drug, leaving behind a sequel of deaths, corruption and drug addiction whose economic costs are difficult to evaluate but certainly are steep.

[1] The Latin American and Caribbean Community of States (with the acronym of CELAC in Spanish) is an intergovernmental mechanism for dialogue and political agreement created in 2011, which includes permanently thirty-three countries in Latin America and the Caribbean. It is a regional forum that brings together all of Latin America and the Caribbean countries and it follows on the footsteps of the SELA, Latin American Economic System, founded in 1976.

[2] Excepting Mexico, which is only a marginal exporter of raw materials.

(The second part of this article will focus on how the economic, financial and political relationship between Latin American countries and China is likely to evolve)

Manuel Suarez-Mier is a Washington, DC-based independent consultant on economic and financial issues. He has taught economics and international finance at various universities in the US and Mexico and was Director of the Center for North American Studies at American University 2014-2015. His numerous posts include chief of staff of the Governor of the Bank of Mexico. He also was Mexico’s top economic diplomat in Washington at the time of the negotiations of the North American Free Trade Agreement (NAFTA) between the US, Canada and Mexico.

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