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January 14, 1999, Thursday, Final Edition

SECTION: FINANCIAL; Pg. E01

LENGTH: 1042 words

HEADLINE: A Crisis With Global Implications

BYLINE: Steven Mufson, Washington Post Staff Writer

BODY:

If you're an average American investor, you've probably never heard of Itamar Franco or the state government he heads in Brazil.

But thanks to this cantankerous governor of an ailing state in a troubled Latin American nation, world stock and bond markets from New York to Frankfurt to Mexico City quaked yesterday at the specter of a new bout of global financial instability, just as the last one seemed to be fading.

Just last week, the tempestuous Gov. Franco declared that his once-wealthy industrial state, Minas Gerais, had been so hard-hit by the economic downturn in Brazil that it wouldn't honor its debts to Brazil's federal government. That triggered a crisis of global investor confidence in Brazil's financial stability, a new bout of capital flight from Brazil, and then yesterday's effective devaluation of the Brazilian currency, the real.

The typical American investor probably views the real as something unreal. But for four months international bankers have described the defense of the real's value as a Maginot line in the battle to restore international financial stability.

That's because so many investors, companies and workers are tied to the fate of Brazil. And because Brazil accounts for 40 percent of Latin America's economic output, its problems are also Argentina's, Venezuela's, Chile's and Mexico's problems. And because 20 percent of U.S. exports go to Latin America, Latin America's problems are U.S. problems too. And because investors tend to tar all emerging market economies with the same brush, instability in Brazil can rock markets in Turkey, the Czech Republic, South Africa and Hong Kong.

"That's been the nature of this global crisis," said Edward Yardeni, New York-based chief economist of Deutsche Bank Securities. "It starts somewhere you never imagined should be that important, like Thailand or a small province in Brazil."

"Historically people thought you could diversify risks between U.S. and developing markets. But there's been convergence and the links are getting closer," said Leila Heckman, managing director for global asset allocation at Salomon Smith Barney Inc., a unit of Citigroup.

Markets reflected that convergence yesterday in the wake of Brazil's currency devaluation. During a volatile day of trading, the market value of all Citigroup stock fluctuated by more than $ 11 billion in just six hours and J.P. Morgan shares tumbled by about 5 percent on fears about the banks' exposures in Latin America. U.S. airline stocks fell on fears that itinerant Latin Americans would travel less. Shares of appliance maker Whirlpool Corp., which had expected to get 10 percent of its 1998 revenue from Brazil, slid 2.1 percent while Spain's Telefonica SA, one of the biggest foreign investors in Brazil, fell 7.2 percent.

Economic analysts now forecast a deep recession for the entire South American continent. A Latin America expert at one major U.S. bank predicted that Brazil's interest rates would climb higher now that the government's credibility is shattered. That would strangle economic growth in Brazil, push up inflation and impoverish millions of Brazilians. The Brazilian budget deficit would grow as tax receipts fall, forcing more borrowing at ever higher rates, now at about 30 percent domestically.

"It is a day to be marked down as a black day for Latin America," the Latin America expert said. "Brazil has just blinked."

For the U.S. economy overall, a downturn in Latin America this year could knock a few tenths of a percentage point off U.S. growth, said Jeffrey Sachs, an economist and director of the Harvard Institute for International Development. "The consequences are not large, but they're not insignificant," he said.

More importantly, many analysts worry that yesterday's devaluation by Brazil would be the opening shot of a new round of global financial tremors by putting pressure on the Hong Kong dollar, the Argentine economy, and emerging markets in general. That could make Brazil's move another step toward a dangerous worldwide cycle of falling prices, incomes and demand for goods, including those produced by U.S. companies.

"Another large segment of the global population is losing its purchasing power, and is desperate for income to make debt payments and make a living," Yardeni said. That would mean more cheap goods and less demand for them, he said. That would further slow U.S. corporate profits, he said, and hurt Europe, where growth has been more export-oriented than in the United States.

Increasingly the United States is what Federal Reserve Chairman Alan Greenspan warned it could not be for long: an oasis of financial stability in a sea of drowning economies. As a result, the world increasingly relies on U.S. consumers as their lifeline.

"The world desperately needs yuppies, and it just lost a whole lot of Asian and Brazilian yuppies," Yardeni said.

That brings analysts back to the U.S. stock markets, whose dizzying heights have helped fuel confidence and consumer spending. "The only thing between global depression is the American consumer. Thank God we were born to shop," Yardeni said. But he warned that "If Latin America and Asia depress U.S. corporate profits and bring stocks down to planet Earth, then we'll all be in trouble."

What Devaluation Could Do

When Brazil devalues its currency, the real . . .

The dollar strengthens, which could in turn . . .

. . . make imports from Latin America into the United States cheaper, which could . . .

. . . pressure U.S. companies to lower prices, which could . . .

. . . squeeze U.S. corporate profits . . .

. . . which could hurt the U.S. stock market.

When Brazil devalues its currency, the real . . .

Global investors could lose confidence in developing markets, which could . . .

. . . spur a sell-off of Latin American debt, securities and stock, which could . . .

. . . limit Latin American companies' ability to raise money . . .

. . . and conceivably cause Latin American economies to shrink, lowering their purchases of U.S. exports . . .

. . . which could hurt the U.S. stock market.

Traders surround the post for Telebras, the Brazilian telephone company, on the floor of the NYSE yesterday.

GRAPHIC: Chart, The Washington Post; Photo, ap/RICHARD DREW

LANGUAGE: ENGLISH

LOAD-DATE: January 14, 1999