When two elephants fight, it’s the grass that suffers. Or so says the old African proverb. But in Latin America the grass seems to be doing rather well from the ongoing jostling between the US and China. In August El Salvador was the latest in a string of Central American countries to switch diplomatic relations from Taiwan to China. In Panama, US protests managed to prevent the opening of a new Chinese embassy on the mouth of the canal but with 26 diplomatic agreements signed in the last year it is merely delaying China’s inevitable influence in the country. It not just in Central America – China’s increased political clout is evident across the region. For example, down in deepest south Argentina it has built a controversial space station, to be operated by the military, that will serve as a strategic monitoring post.
For lovers of geopolitics it’s fascinating to see two superpowers vie for interest in a strategic region – a bit like the Great Game between Britain and Russia in the 19th century. But for investors the underlying economic story is more interesting. The reason China has more political influence is because during the last decade it surpassed the US as the most important trade partner for major Latin American economies. It’s also become a major investor, with Chinese firms making the most corporate acquisitions in the region. Finally, its state-to-state lending has also rocketed, and is now a bigger source of financing to Latin American governments than the World Bank and regional equivalents. China’s emergence as a major player in Latin America is great news for the region’s economies. It reduces dependence on the US, diversifies its sources of finance and investment and opens up new export markets. That’s positive for investors in Latin America as it will boost economic growth and asset prices over the coming decades.
Why does China like Latin America so much?
The Thucydides Trap, named after the eponymous Athenian general and historian who observed the Peloponnesian War, posits that a rising power will inevitably go to war with the declining incumbent. In the 20th century rising industrial forces, such as Germany and Japan, eventually clashed with the existing powers over control of the natural resources needed to sustain their economic growth. In densely populated east Asia, China is hemmed in by nuclear Russia to its north, fellow rising power India to its west and US-backed Japan to its east. Of course, it has done a tremendous job of gaining access to commodities in the smaller states of south east Asia but none offer the scale of supplies available in Latin America. Clearly for the world’s most-populous country and soon-to-be largest economy, a key long-term goal is to ensure adequate supplies of energy, food and industrial metals.
And Latin America is uniquely abundant in all three. In energy it has around 20% of the world’s oil and gas reserves but less than 10% of its population, making it a natural exporter. In agriculture it already has a dominant share in key global export markets, for example 60% of world soybean exports, 44% of beef, 42% of poultry and 33% of corn. Moreover, with 33% of the world’s freshwater supplies and the most additional available arable land in the planet, it has great potential to expand. Meanwhile in mining it is rich in base metals, with the world’s largest reserves of copper, and around a quarter of zinc reserves. It also looks well placed in metals with more cutting-edge applications. For example, 54% of the world’s reserves of lithium – essential for the batteries that will power the renewable energy revolution and electric vehicle boom – can be found in the ‘lithium triangle’ of Bolivia, Chile and Argentina.
[quote]China’s emergence as a major player in Latin America is great news for the region’s economies…[/quote]
Geopolitical considerations like the Thucydides Trap might sound a bit grand for small private investors like us but they are long-term trends that give structural support to our story. China began beefing up its presence in Latin America at around 2005, as the commodity boom kicked off. But the economic relationship will outlast the vagaries of particular commodity cycles because the region is the only sustainable source of the essentials that China needs to maintain its economic growth. Of course, this isn’t the first time that a rising superpower has taken an interest in Latin America. But there is a difference this time. Unlike previous changes of the guard in the region – when Britain replaced Spain as the most important international trade and investment partner at the beginning of the 19th century, or when it was then supplanted by the US after the First World War – the outgoing incumbent, the US, isn’t going anywhere. Even when China overtakes the US as the world’s largest economy, geography means that it’s going to remain a major presence in Latin America. As a result, the region will benefit from the sustained attention of two competing investors over the coming decades.
China’s three-pronged approach
The most impressive aspect of China’s rise in Latin America is how quickly it has happened. It has been based on three pillars: trade, investment and finance. At the turn of the century Chinese economic interaction with the region was negligible. Now it has usurped the US as the main trading partner of Brazil, Latin America’s largest economy. The $76billion of goods traded between them make up a fifth of Brazil’s total trade. In Chile and Peru, where the bilateral commerce with China is worth $34billion and $21billion respectively, it accounts for around a quarter of each country’s total international trade. Unsurprisingly the main Latin American exports are commodities, with Brazil sending soybeans and iron ore, and Chile and Peru mainly copper. While in return they get a mixed basket of Chinese cars, electronics and industrial equipment. The pattern is repeated across South America. In Central America, which is less rich in commodities, trade is incipient but rising rapidly. The only exception is Mexico, whose world-leading manufacturing and free trade deal make it a genuine competitor to China in the US market. The arrival of this new, massive trading partner has created winners and losers in the Latin American economies but generally it’s been good news. The commodity exporters tend to have a trade surplus with China, which generates hard currency earnings that have been reinvested in the local economies. Mexico has a trade deficit with China but many of these imports are inputs for manufactured goods that are later re-exported to the US.
The second prong is investment. The Economic Commission for Latin America and the Caribbean (ECLAC) estimates that Chinese buyers accounted for 41% of the internationally funded mergers and acquisitions in Latin America in 2017, worth around $18billion. To put that buying spree in perspective, US firms were behind just 6% of M&A activity. What’s really remarkable is that Chinese foreign direct investment (FDI) to Latin America increased in 2017 amid a sharp drop in Chinese FDI to the rest of the world. According to ECLAC Chinese FDI worldwide fell by 36% as the government decided to “better align FDI flows with the country’s strategic priorities”. Remember, it is mostly state-owned companies making the Chinese acquisitions, so they reflect government policy. The most famous of the strategic priorities is the “One Belt, One Road” programme, that involves building billions of dollars of infrastructure abroad to improve trade links to China. In other words, the type of investments China makes in Latin America fit with the country’s long-term game, which is why FDI to the region remains strong. Indeed, ECLAC analysis shows that Chinese FDI in Latin America is almost entirely focused on commodities and infrastructure, unlike in other places, such as Europe and the US, where it focuses more on technology.
[quote]Before 2006 these two banks had barely lent a peso to Latin America. But since then they have made loans worth more than $150billion…[/quote]
The final prong is state-to-state financing, which China implements through the China Development Bank (CDB) and Eximbank. Before 2006 these two banks had barely lent a peso to Latin America. But since then they have made loans worth more than $150billion, estimates Boston University’s China–Latin America Finance Database. That’s far more than comparable Western institutions, such as the World Bank, managed in the same period. The distribution of these loans reflects Chinese priorities in the region, with the major beneficiaries being oil-rich Venezuela with more than 40% of the total, Brazil 20% and Argentina and Ecuador with roughly 10% each. Clearly China doesn’t lend this money for altruistic reasons. Boston University’s Kevin Gallagher notes that the loans are meant to support China’s national interest, “including Beijing’s domestic reform agenda and complex energy security calculus. The policy banks therefore continue to offer oil-backed loans to LAC nations, and to support projects that employ China’s excess capacity, among other objectives.” But they are popular with Latin American governments as they offer an alternative form of financing to ‘meddling’ institutions like the World Bank and fickle international bond markets.
How Latin America Benefits
Many Latin American governments are naïve about China’s growing political and economic influence. Lots of Latin American countries have legitimate complaints about their historic treatment at the hands of the US but if you look at, say, Venezuela, it has simply swapped one rich foreign backer for another. In the same way that the US propped up various nasty Latin American dictatorships in the 20th century, earlier this year China lent Venezuela $5billion, which will prolong the cruel government of Nicolas Maduro. Another problem is that the terms of the loans are far less transparent than an international bond issue, which isn’t ideal for a region cursed with corrupt elites. Meanwhile we have seen a spate of grand Chinese infrastructure projects, such as the transoceanic Nicaraguan Canal, that were announced but never realised.
On a company level, China has proved a fierce competitor for Latin American manufacturers, decimating many niche domestic industries, such as Argentine shoes. In Costa Rica pineapple growers are suffering from a supply glut following their unsuccessful attempt to break the Chinese market. They boosted production on Chinese price promises that didn’t materialise and found that when the deal went sour, they were not in an equal negotiating position. As one producer told me, “we found out that in China we are nobody”. In broader terms it could be argued that China’s demand for Latin America’s commodities, and the exchange for Chinese manufactures, will prevent the region from diversifying its economies. Put simply it’s hard for small Latin American countries to beat a giant like China.
But despite all of those valid qualms, the rise of China is still a positive for the region. One reason is that all of the challenges listed above were already inherent in Latin America’s relationship with the US. Now at least there are two giants negotiate with. My optimism is shared by Latin American leaders. In the rich West the recent US arrest of the CFO of Chinese telecommunications firm Huawei shows that Chinese investment is increasingly viewed with suspicion. But in Latin America it is still welcomed with open arms. Even when new leaders come to power, such as Mauricio Macri in Argentina or Lenin Moreno in Ecuador, they may renegotiate their predecessors’ China deals but they don’t rip them up.
The second reason is pure maths. China’s rise, its increase of trade deals with Latin America and the infrastructure projects it is building in the region open up a massive market for a wide range of Latin American goods. Some clear winners in the long-term are the traditional commodity exports that powered Latin America’s golden decade in the first part of this century. Now, on top of that, you now see value-added agro-industrial products such as Ecuadorian shrimp, Peruvian berries and Chilean wine all starting to find their way into Chinese homes. Plus we can expect wave of Chinese tourists to Latin America, which counts as an export for the region. Finally, there is the finance. Latin America has traditionally been starved of capital, which has led to a lack of investment in infrastructure. China’s desire to build the roads and ports needed to facilitate trade, plus its need to use up its spare capacity now its own building boom is slowing, will help Latin America finally fix its infrastructure deficit giving a big boost to economic productivity. All of this is great for investors in the region.
A version of this article first appeared in MoneyWeek on the 14th of December.