We will post a monthly commentary on the U.S. and Latin America around the 15th of each month. We will also post comments on latest economic developments, as they arise.

                      StratInfo - Strategic Information Analysis Inc.   
                                        Miami, Florida, U.S.A.
                                             April 13, 2001

                                                U.S. Economy                                                                                     

• As we had predicted, the Fed lowered the Fed Funds rate by 50 basis points in the March FOMC meeting. In its statement, the Fed referred to signs of excess productive capacity, which "could continue for some time and the potential for weakness in global economic conditions." We presume that this statement implies a change in Mr. Greenspan’s February 28 forecast of GDP growth for this year of 2.25 - 2.50 percent as part of his congressional testimony. Based on the Fed’s new economic model, we think another rate cut of as much as 50 basis points, to 4.50 percent is possible by the next meeting. The June Fed Funds futures are currently trading at 4.46 percent, which is consistent with this prediction.

• The driving theory of recent policy actions is what we call economic sentimentalism. Suddenly, the consumer sentiment index has become a key factor in policy decisions. The linkage between consumer sentiment and the state of the economy is viewed to work through the equity market. In other words, fears of a huge stock market drop will result in a cutback in consumer spending. Interestingly, empirical economic analysis has not been successful in using the consumer sentiment index to forecast economic conditions. On the other hand, while the S&P 500 full return index declined by 9.1 and 6.3 percent in February and March respectively, the University of Michigan consumer sentiment index increased in March to 91.5 from 90.6 in February. However, now index readings are being reported on a bi-monthly bsis, if we could only have a daily reading of the index, just imagine how many more times the equity markets could be turning!

• The Fed also appears to have temporarily discarded the quantity theory of money in favor of what we call the quantity theory of wealth expectations. Whereas the quantity theory of money predicts nominal spending on the basis of the money supply, usually M2, now the Fed seems to be using the value of the S&P500 or the NASDAQ index to predict nominal spending. If so, then this model would lead us to expect another 50 basis points decline in the Fed Funds rate. In the new model equation, money times velocity of money is substituted by expected wealth (based on the equity market valuation) times a constant times one minus the marginal propensity to save. One troubling thought is that economists consider any transitory increase in income, resulting from shifting equity values, as having a minimal impact on consumption. The Fed’s view seems to contradict this notion.

• We think inflation poses the main risk in the short-term. The trend CPI inflation rate is running at a 3.5 percent rate. The Fed’s actions are adding to money in circulation, thus contributing to more inflation during the second half of this year. Based on this scenario, we continue to forecast "stagflation" followed by recession, perhaps next year. We thus expect GDP growth of about 1.5 percent this year. The financial media reports that many economists now consider 3.5 to 4.0 percent growth as the normal potential growth rate. We are not clear as to how one could arrive at that conclusion based on only a few years of data.

• Our forecast scenario includes anoticeable slowdown this year, but with stubborn inflation and we do think a recession will follow. However, if we based our assessment on the daily media headlines, we would have to conclude that we are already in a recession. Many of the headlines contain the following generic heading: "such and such indicators reached their worst level in the past 20 months!". A recent report mentioned that the unemployment rate had "JUMPED" to 4.3 percent, from 4.2 percent. Perhaps one explanation for business cycles could be a very short memory expanse of business and consumers. The unemployment rate has averaged 5.9 percent during the past 40 years, a figure that is noticeably higher than the current 4.3 percent. The weakest link in the economy is the industrial sector, which has posted declines during the past five months. On the other hand, the unemployment rate remains at a fairly low rate of 4.2 percent.

• In January of this year we estimated the current account deficit for 2000 at $434 billion, the preliminary estimate released last month was $435.38 billion, This is about 4.7 percent of GDP. As we have said in the past, the external deficit is likely to create problems for the dollar, and thus complicate the management of monetary policy.

Latin American Economies 

• Dramatic changes have taken place in Argentina during the past month. In the midst of a pervasive recession and under heightened social pressures, president Fernando de la Rua appointed Domingo Cavallo as Economy Minister. As the architect of the Convertibility Plan, Mr. Cavallo acquired a reputation as dragon slayer. At the request of president de la Rua, the Argentine Congress promptly granted him especial powers, that turn him into an economy czar, to deal with the current crisis.

• Mr. Cavallo immediately sought to calm the markets by guaranteeing continued support for parity with the US$. He also announced an economic program that seeks to cut fiscal spending mainly by consolidating and eliminating government agencies. The most important measure announced so far, is an increase in import tariffs for non-capital goods. In an effort to stimulate investment and production, the tariffs for capital goods have been eliminated. Argentina also issued new bonds for $3.5 billion to cover the burgeoning fiscal deficit.

• We are still concerned about Argentina’s heavy debt burden and think it is very likely that they will encounter debt service problems. It is not a good symptom that one of Mr. Cavallo’s first action was to borrow money once again. In an effort to help troubled Argentina, the U.S. government is nudging U.S. banks to postpone for one year Argentina’s payments on about $7.0 billion owed to those banks (this would constitute the first rescheduling exercise).

• For the first time since the adoption of parity with the US$, a high government official, Mr. Cavallo , has talked about tying the peso to a currency other than the dollar. Mr. Cavallo is talking about tying the peso to the euro, when and if the euro gets to be on a par with the dollar. It is very unclear how he intends to tie the currencies, although we think it could constitute a de facto devaluation.

• In Bolivia, the Superintendency of Banks announced, in its last report, that problem loans amounted to 17 per cent of total bank loans. Many local firms are unable to fulfill their financial obligations, due to sagging domestic demand and are now demanding government help to restructure their loans

• Brazil is once again suffering the consequences of Argentina’s economic difficulties. The real has been getting a beating in the markets in anticipation of economic woes in Mercosur, if the Argentine economy continues mired in recession. The Central Bank opted for an increase in interest rates to prop up the currency.

• Chile’s Central Bank cut interest rates again to 3.75 percent from 4.0 percent, in an effort to prod economic activity.

• Inflation has been subdued, during the first quarter, in Colombia. Agricultural output is picking up. However, unemployment is still high and violence persists. The government has shown extreme flexibility towards the guerrillas, but refuses to deal with the powerful paramilitary forces.

• Banana production and exports in Costa Rica has been falling by 8.5 percent in the first quarter, due to adverse weather.

• The president of Dominican Republic’s Central Bank has expressed concerns about the nation’s debt service payments and mentioned the possibility of a renegotiation of the Paris Club debt and a bond issue. All this will require an IMF agreement.

• The IMF has extended its present agreement with Ecuador until June, to give the government an opportunity to obtain congressional approval for a VAT increase from 12 percent to 15 percent. Congress already rejected the increase at the end of March and the government sent the bill back to Congress for another try. The IMF considers that the increase is necessary to narrow the budget gap.

• With a burgeoning fiscal deficit looming large for at least the next two years, the Salvadorean government is contemplating tax increases.

• The fiscal deficit is also a concern in Guatemala, where there is talk about the possibility of a, yet undetermined, VAT increase.

• There is optimism in Honduras with respect to sugar output and exports this year. However, low coffee prices in the international markets are hurting export gains and prospects for faster economic growth.

• The economic deceleration in the U.S. is starting to affect the Mexican maquiladoras. Volkswagen closed a plant, citing sagging U.S. demand as the reason. Nevertheless, strong capital inflows, driven by the expectation that Mexico’s economy would outperform the U.S. economy, have been bolstering the peso.

• Political jockeying continues in Nicaragua, in preparation for the November presidential elections.

• The Panamanian government already received recommendations to reactivate the economy, from a public/private sector commission appointed by president Mireya Moscoso at the beginning of the year. The recommendations include infrastructure spending and the prompt implementation of stagnant government plans and programs.

• In Peru, Alejandro Toledo and Alan Garcia will be in a runoff for the presidency. Surprisingly, former president Garcia pulled ahead conservative Lourdes Flores by a narrow margin. According to preliminary computations, no one obtained a majority in Congress. Toledo’s Peru Posible has 45 seats, followed by Garcia’s APRA with 27 and Lourdes Flores’ Unidad Nacional with 17. A number of other parties obtained less than 15 seats.

• Ms. Flores has so far declined to endorse any presidential candidate in the runoff. But, it is believed that the majority of her followers and those of Fernando Oliveros will vote for Toledo.

• The potent resurgence of populist APRA and especially Alan Garcia is making the markets nervous. During Alan Garcia’s presidential period in late 1980's, hyperinflation reached record heights, while economic performance sank. Garcia is better remembered as the Peruvian president who suspended the payment of the nation’s foreign debt.

 

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