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How the full opening of the capital account to highly liquid financial markets led Latin America to two and a half cycles of ‘mania, panic and crash’

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  • Palma, J. G.

Abstract

Latin America has recently experienced three cycles of capital inflows, the first two ending in major financial crises. The first took place between 1973 and the 1982 ‘debt-crisis’. The second took place between the 1989 ‘Brady bonds’ agreement (and the beginning of the economic reforms and financial liberalisation that followed) and the Argentinian 2001/2002 crisis, and ended up with four major crises (as well as the 1997 one in East Asia) — Mexico (1994), Brazil (1999), and two in Argentina (1995 and 2001/2). Finally, the third inflow-cycle began in 2003 as soon as international financial markets felt reassured by the surprisingly neo-liberal orientation of President Lula’s government; this cycle intensified in 2004 with the beginning of a (purely speculative) commodity price-boom, and actually strengthened after a brief interlude following the 2008 global financial crash — and at the time of writing (mid-2011) this cycle is still unfolding, although already showing considerable signs of distress. The main aim of this paper is to analyse the financial crises resulting from this second cycle (both in LA and in East Asia) from the perspective of Keynesian/ Minskyian/Kindlebergian financial economics. I will attempt to show that no matter how diversely these newly financially liberalised Developing Countries tried to deal with the absorption problem created by the subsequent surges of inflow (and they did follow different routes), they invariably ended up in a major crisis. As a result (and despite the insistence of mainstream analysis), these financial crises took place mostly due to factors that were intrinsic (or inherent) to the workings of over-liquid and under-regulated financial markets — and as such, they were both fully deserved and fairly predictable. Furthermore, these crises point not just to major market failures, but to a systemic market failure: evidence suggests that these crises were the spontaneous outcome of actions by utility-maximising agents, freely operating in friendly (light-touched) regulated, over-liquid financial markets. That is, these crises are clear examples that financial markets can be driven by buyers who take little notice of underlying values — investors have incentives to interpret information in a biased fashion in a systematic way. ‘Fat tails’ also occurred because under these circumstances there is a high likelihood of self-made disastrous events. In other words, markets are not always right — indeed, in the case of financial markets they can be seriously wrong as a whole. Also, as the recent collapse of ‘MF Global’ indicates, the capacity of ‘utility-maximising’ agents operating in unregulated and over-liquid financial market to learn from previous mistakes seems rather limited.

Suggested Citation

  • Palma, J. G., 2012. "How the full opening of the capital account to highly liquid financial markets led Latin America to two and a half cycles of ‘mania, panic and crash’," Cambridge Working Papers in Economics 1201, Faculty of Economics, University of Cambridge.
  • Handle: RePEc:cam:camdae:1201
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    References listed on IDEAS

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    Cited by:

    1. Mario Cimoli & Jose Antonio Ocampo & Gabriel Porcile & Nunzia Saporito, 2020. "Choosing sides in the trilemma: international financial cycles and structural change in developing economies," Economics of Innovation and New Technology, Taylor & Francis Journals, vol. 29(7), pages 740-761, October.
    2. Reyes, Luis, 2017. "The link between the current international monetary non-system, financialization and the Washington consensus," Research in International Business and Finance, Elsevier, vol. 42(C), pages 429-441.
    3. Özgür Orhangazi & A. Erinç Yeldan, 2021. "The Re‐making of the Turkish Crisis," Development and Change, International Institute of Social Studies, vol. 52(3), pages 460-503, May.
    4. José Gabriel Palma & Joseph E. Stiglitz, 2016. "Do Nations Just Get the Inequality They Deserve? The “Palma Ratio” Re-examined," International Economic Association Series, in: Kaushik Basu & Joseph E. Stiglitz (ed.), Inequality and Growth: Patterns and Policy, chapter 2, pages 35-97, Palgrave Macmillan.
    5. Nina Dodig & Hansjorg Herr, 2014. "Previous financial crises leading to stagnation – selected case studies," Working papers wpaper24, Financialisation, Economy, Society & Sustainable Development (FESSUD) Project.
    6. Antonia Lòpez-Villavicencio & Luis Antonio Reyes Ortiz, 2018. "Is globalisation taking away jobs? An empirical assessment for advanced economies," CEPN Working Papers halshs-01895223, HAL.
    7. José Gabriel Palma, 2022. "Finance as an (ever more fragile) ‘perpetual mania’: have they all lost their collective minds?," Cambridge Journal of Economics, Oxford University Press, vol. 46(4), pages 773-825.
    8. Antonia Lòpez-Villavicencio & Luis Antonio Reyes Ortiz, 2018. "Is globalisation taking away jobs? An empirical assessment for advanced economies," Working Papers halshs-01895223, HAL.
    9. Palma, J. G., 2019. "The Chilean economy since the return to democracy in 1990. On how to get an emerging economy growing, and then sink slowly into the quicksand of a “middle-income trap”," Cambridge Working Papers in Economics 1991, Faculty of Economics, University of Cambridge.
    10. Luis Antonio Reyes Ortiz, 2017. "The Link between the Current International Monetary Non-System, Financialization and the Washington Consensus," Post-Print halshs-01895218, HAL.
    11. Giuliano Toshiro Yajima, 2022. "Chile: The Road to Joy Is Paved with Obstacles," Economics Policy Note Archive 22-3, Levy Economics Institute.

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    More about this item

    Keywords

    Causes of financial crisis; Latin America; East Asia; Financial liberalisation; Neo-liberal economic reforms; Systemic market failure; Keynes; Minsky; and Kindleberger;
    All these keywords.

    JEL classification:

    • D7 - Microeconomics - - Analysis of Collective Decision-Making
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • H12 - Public Economics - - Structure and Scope of Government - - - Crisis Management
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • N2 - Economic History - - Financial Markets and Institutions
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • O43 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Institutions and Growth

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