Financial Crisis Brewing

NEW YORK — Hypnotized by the Nasdaq's worst calendar year ever and the Dow Jones' brief visit to bear-market land, most U.S. citizens have paid little attention to the storm clouds rising over the international economy. That could be a mistake. Japan's continuing economic decline is absorbing more and more high-level Washington attention; Asian economies, still fragile after the 1997-98 financial crisis, are reeling under the impact of the slowdowns in the United States and Japan; a Turkish financial crisis that began late last month raises basic questions about the health and stability of one of America's most important allies.

However, as important as all these problems are, a new Latin crisis is beginning to look ominously possible. A financial meltdown in Latin America, affecting countries like Argentina, Brazil and Mexico, could create major social, economic and political problems for the United States.

Start with Argentina, where economic problems are causing one political upheaval after another. Ten years ago, in an effort to stop decades of inflation and hyperinflation, Argentina adopted a stringent "dollar convertibility" program. Since 1991, the Argentine peso has been set equal to one dollar. At the same time, the country embarked on an ambitious program of privatization and market-oriented reforms. At first, the results were promising. Inflation dropped from more than 3,000% a year in 1989 to -0.8% last year, and GDP growth averaged 6.2% during the 1990s.

Then trouble came. The high U.S. dollar made Argentine exports expensive. The national debt ballooned--at more than 50% of gross domestic product, it is one of the largest in Latin America--and as unemployment rose to 14.7%, the economy went into a recession.

Argentina is trapped. Free-market re-forms are now so unpopular that governments can't get them through Congress. Foreign creditors are nervous, demanding higher interest rates to compensate them for the risk that Argentina will devalue its currency or default on its debt. High interest rates and a lack of progress on reforms help keep the economy in recession.

Where this will end up isn't clear, but it's getting harder and harder to imagine a happy ending. Already, Argentina's problems are spilling over into Brazil. Investors have been selling Brazil's currency, the real, out of fear that Argentina's economic and currency problems will weaken its neighbor. By early this week, the real had fallen 10% since Jan. 1, more than twice the decline that the central bank had projected for the whole year. Sooner or later, currency weakness could force the Brazilians to raise interest rates as well, crippling an already weakened Brazilian stock market and threatening the country with a return to recession as well.